Dear Wall Street: Happy Anniversary. But after 10 years, how do we know we're still in love? Better try and count the ways.
Exactly 10 years ago today, the bear market of the inflation-ravaged 1970s finally breathed its last. The Dow Jones industrial average bottomed at 776.92 on Aug. 12, 1982. The following day, Friday the 13th, the Dow jumped 11.13 points and the bull market was born--though at the time, of course, few people recognized it.
By the end of 1982, the Dow had rocketed 35% from the August low, and stood at 1,046.54. Yet throughout those late-summer and fall months, many investors simply stared at the market in disbelief as it rose. Why, they asked, should stocks go up when the economy was so weak, interest rates still high and inflation still a threat?
Sound familiar? To Wall Street's optimists, the incessant intoning of those same fearful questions in 1992 gives much comfort. Markets don't go down when everyone expects that they must, the bulls note. They see the high level of anxiety today as a sure sign that a sustained market surge lies ahead.
But many of those bulls also insist that they're realists: You'll make good money in stocks over the next 10 years, they say, but it won't be the 329% gain the Dow achieved over the last 10 years, from 776.92 then to 3,331.10 now.
"I think the best that anyone can reasonably hope for is that stock prices double over the next decade," says Bradlee Perry, a veteran investor who chairs the David L. Babson & Co. mutual funds in Cambridge, Mass.
If a 6,662 Dow doesn't seem like much looking 10 years out, it's still going to beat the alternative of staying in short-term cash investments, Perry says.
The bulls' outlook of restrained optimism stems from their positive read of the stock market's greatest obsessions: interest rates and corporate earnings.
As David Blitzer, economist at Standard & Poor's Corp. in New York, puts it: "The stock market likes two things--falling interest rates and rising corporate earnings." The rest is just a lot of noise.
In August, 1982, half of that equation was enough to start a bull market. While corporate earnings were still in a deep slump, the Federal Reserve's continuous credit easing started a long decline in interest rates, which in turn gave the bull market its spark of life. An economic recovery, and an earnings recovery, soon followed.
This year, ironically, Wall Street has enjoyed falling interest rates and the beginning of an economic and earnings rebound. Yet that double-barreled shot has failed to impress many investors. A broad measure of the stock market, the Standard & Poor's 500 index, stands at 418.90--virtually unchanged from 417.09 at year's end.
Clearly, fear of the future has frozen many investors in their seats. And there is, of course, much to fear: $4 trillion in federal debt, high unemployment (and continuing layoffs), depressed consumer confidence, Japan's ongoing bear market and a former Soviet bloc that may yet explode into civil war and anarchy.
Babson's Perry doesn't minimize the problems. But when he looks back to 1982, he sees a few things that appear much worse in retrospect.
"We were coming off the highest inflation rates and highest interest rates in U.S. history," he remembers. While many economists gripe that today's 7.31% yield on 30-year Treasury bonds is still too high--relative to inflation--to allow for a sustained economic recovery, that bond's nominal yield of 13.09% in August, 1982, was in many ways more daunting.
If the stock market--and the economy--weathered those sky-high interest rates of the early 1980s, can we really expect a worse outcome from today's lower (and still falling) rates? Perry asks.
While bearish investors view the market's hesitance this year as a sign of a coming collapse, Perry turns that around: The fact that stocks have been able to hold up well in the face of mounting Wall Street fears is an excellent sign, he says.
Hold on, say the bears. You can't argue that this is 1982 all over again, because stocks then were dirt-cheap compared to earnings per share. That August, the average stock sold for just eight times expected 1982 earnings. Many great stocks sold for even less.
Today the average stock sells for 18 times expected 1992 earnings, near the historical high for that important market measure.
Perry says the bears miss the point. He's not arguing that stocks can duplicate the '80s rise. But they can do well while remaining at high price-to-earnings ratios, he insists. From the early 1960s to early 1970s, for example, price-to-earnings ratios stayed in the high teens as interest rates and inflation remained low. Many stocks advanced dramatically.
If you assume that we're stuck with a slow-growth economy for years to come, Perry notes, then low interest rates and low inflation look like good assumptions as well. And in that environment, stocks have historically flourished.