This Time it’s Different?

By on May 10, 2006

Originally published on:

September 20, 1996

The market has shown significant strength lately. Some of the weaker groups like technology and retail have come to life. There is a lot of speculation on what the Fed is going to do. I wouldn’t worry a bit about their decision on rates. Stocks are going to forge ahead no matter what they do. Pessimism is fairly high and this market is poised to climb this wall of worry.

This Time it’s Different?

One of the most dangerous things an investor can say to themselves is “This time it’s different.” There has been a strong tendency in the past for the market to punish anyone who ever considered that long time valuation indicators where outmoded. However, as I will try to show, times have the potential to change. We are currently in a position to wonder whether things have changed significantly enough so that old ways of valuing the market can be discarded. We have to look at the facts as we see them and even if we think we know what the facts are, they can get muddied by noise and we, as human beings, can confuse realities which flaw our view of the world. To make an educated judgment we have to look at everything available and analyze it objectively without any preconceived notions.
There are many factors which have contributed to the demise of old valuation measures. It used to be that the market would collapse when the dividend yield on the S&P 500 got as low as 2.5 – 2.75%. On the other hand, you could count on a bull market beginning when the yield of the market got as high as 6%. This benchmark is now around 2.2%; significantly lower than lows achieved in past market cycles. The main reason for this shift is that companies are finding other options for the excess cash generated by their businesses. Instead of increasing dividends at the rate they did in the past they are buying back the companies stock, investing in the productive capacity of the business, and buying other companies more than ever before. The result of all this is that, on average, companies are paying out a significantly lower percentage of their earnings capacity in the form of dividends to shareholders than they did in the past. So instead of a yield range of 2.5 – 6.0% from cycle high to low, the range may have shifted to 1.5 – 5.0%. If this is the case, we may not be as close to the peak of this bull market as some would have you believe. If the yield on the Dow were to fall to 1.5%, the index would be around 8,500. Of course, if the market went to a yield of 5.0%, we would experience a historic bear market. At a yield of 5.0% the Dow would be around 2,500. Please don’t misunderstand this as a prediction, but just some interesting possibilities. However, I do believe that a Dow of 8,500 is much more likely than 2,500 as we approach the next millennium.

We know that Communism as an ideology and way of government is falling by the wayside. This is probably the biggest boon to the financial markets since their beginning. There have been many wars and arms buildups in the past which have created a huge, almost unfathomable waste of human, productive, and material resources. We are currently enjoying an era of relative peace and calm in human history. Isn’t this a development sufficiently significant in nature to alter the valuation balance? The jury is still out on that, but I’m beginning to feel that the beginnings of a major shift have occurred.

Most of the world lives in relative poverty when compared to the American lifestyle. The people in these poor countries, for the most part, crave a more affluent, materialistic existence. This is simply human nature. There are billions of potential consumers in the world that companies are ready to convert to a consumeristic way of being. In fact, demographics in the developing countries, with their huge populations, are skewed toward a younger population base while ours is concentrated in the group from 40-60 years of age. I really don’t think the stock markets of the world truly reflect the potential of all of this pent-up demand.

I could write more about this, but my publishing deadline does not allow me to. The fact that I changed this from a weekly to a bi-weekly publication has not created as much additional time as I hoped.

Poor Mike Metz

Every time we have a major market move I like to turn on CNN Moneyline or CNBC to see people’s reaction to the market developments. Many times over the past two years Michael Metz, Chief Market Strategist of Oppenheimer has been interviewed and he is always bearish! He usually refers to something about weak earnings, increasing inflation or the over enthusiasm for mutual funds to justify his position. How a guy as highly paid as he is can be so wrong and still keep his job is beyond my understanding. Another mystery is why these networks continue to request his opinion. He must have been awfully good early in his career or maybe he’s the last analyst left willing to promote the bearish side! Isn’t that a scary thought.

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