Wednesday, October 22, 2008

"Market Downturn Shatters Faith in Stocks"

In a post a few months ago ("A Secular Range-Bound Market?"), we discussed Vitaliy Katsenelson's thesis that we are currently in a secular range-bound market1 that started in 2000 that will likely continue for another ten years or so. The key driver of these secular range-bound markets, in Katsenelson's thesis, is multiple compression, driven by psychology: as investors give up on stocks, stocks gradually start trading at lower multiples. By the end of the last secular range-bound market in 1982, for example, the S&P 500 traded at 9x its trailing twelve months' earnings; at the end of the previous secular range-bound market, in 1950, the S&P traded at 7x its trailing earnings. An article in today's Los Angeles Times, "Market downturn shatters faith in stocks", gives some anecdotal examples of investors giving up on stocks:

Even now, the vast majority of investment advisors would strongly urge people not to give up on stocks, especially when most of the damage to their portfolios arguably has already been inflicted.

Most individual investors are sticking with that advice.


But for many, this time is different.

"What's really scaring investors today is whether this mega-meltdown will take 25 years to get back to even, like it did after the Great Depression," said Sam Stovall, chief investment strategist at Standard & Poor's.

The article goes on to quote a couple of boomer investors; the first quote is from a 55-year old accounting consultant named Don Abbee:

"I feel fairly helpless, and I don't know what I can do to change it," he said. "If you stay in the stock market long enough, it's supposed to come back up, but I'm becoming more skeptical. This market feels different."

Bill Orton, a 46-year-old political consultant, is going through a similar apostasy. His faith in the stock market, merely shaken by the tech crash, is now shattered, he said.

A stock fund he bought a few years ago has plunged in value, while U.S. savings bonds he picked up at the same time have been a rock of stability. Orton now declares himself finished with stocks.

"But I am feeling really good about those savings bonds," he said. "I like bonds."

When enough investors decide that they like bonds too, we'll probably see the average dividend yields on stocks rise until stocks become attractive to them. It's worth remembering that there have been times when the average dividend yield on stocks was higher than the average yield on corporate bonds.

1Secular, Katsenelson's terminology, refers to trends that last for 5 years or longer; cyclical refers to trends that last for less than five years. So the current secular range-bound market has included the cyclical bear market from 2000-2002, the cyclical bull market from 2002-2007, and the current cyclical bear market.


Daniel said...

I have absolutely no doubt in my mind we'll all be as rich as we once were in dollar amounts in far less than 25 years.

The only catch is that the buying power of those dollars will most likely be dramatically different. Not in a good way.

JK said...

So daniel is it true then that it really is impossible to get something for nothing? I thought our freinds at the Fed said fighting inflation is their top priority.

*Kudlow voice* Have faith in King Dollar! You will never go wrong betting on America!

DaveinHackensack said...

King Dollar has actually been ascendant recently. It's been a saving grace for us that foreigners are still willing to pour their money into U.S. Treasuries in a flight to safety. How many countries can open up the fiscal and monetary spigots like we are doing now and see their currency go up (at least in the short term)?