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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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Economy cyber pirates who talked up the price of stocks in order to make money off unsuspecting investorsPREDICTIONS AND CONCLUSIONS The study of history is a powerful antidote to contemporary arrogance. It is humbling to discover how many of our glib assumptions, which seem to us novel and plausible, have been tested before, not once but many times and in innumerable guises; and discovered to be at great human cost, wholly false. Paul Johnson (historian) The Past is Prologue Remember that the future is neither ours nor wholly not ours, so that we may neither count on it as sure to come nor abandon hope of it certain not to be. Epicurus, 3rd century BC Let me state at the outset that this chapter is not about predictions of the sort I make in my monthly newsletter or my Weekly Market Update. In these pub lications, I am able to give, buy, and sell points and discuss more exactly where markets are likely to be headed. I only have to be right for between 1-8 weeks. A book has a very different time horizon. The goal of this chapter, therefore, is not to pontificate where markets and the economy will be a few years from now, but to offer some context within which you can construct your own evolving model or perspective, as events and stock market action cause a change in view. And, if I have done my job successfully, you now have the tools to adjust this model to fit an ever-evolving picture. Let me reiterate that what moves markets is how profitable underlying companies are. Economics moves markets over the longer term. When you buy a stock, you are not just buying a piece of paper and betting against somebody else on the direction of that stock. You are buying part of a business, which in turn is tied to the economy. In the last 10 years, this link between the real economy and stock prices seems to have been forgotten. TAKING A VIEW At the beginning of 2002, a number of advisors are suggesting that it wont be long before the uptrend that began in 1990 resumes. I disagree, not about the possibility of a new uptrend beginning in 2002-3, but in the type of up-move that might be. In Chapter 3, we talk about Taking a View. If one takes a view of the last 20 years, the bear markets of 1982, 1987, and 1990 were minibear markets within a major bull market. But implicit in the idea that this recession could be over by mid-2002 is the belief that the excesses of the past 10 years have: (a)Not appreciably affected the internal structure of either the stockmarket or the economy. (b) That all the reasons that sustained the bull market that began in 1982 are still valid. That the declines over the past 2 years have wiped out all the excesses of a bubble market, and bad dot-com business plans, in exactly the same way the deliberate squeezing of inflation out of the economy did in 1981-82. (c) That the war on terrorism will be (in a fighting sense) an instant war, like the Gulf War, with a rapid end and all fighting/war strategies will work fairly well. I believe that all three premises are wrong, and I will deal with (a) and (b) in this chapter and (c) in Chapter 20. PAST MAJOR BULL MARKETS Before we further consider what the next few years might be like, we need to look at past major bull markets to examine their similarities after past boom periods. There are two such periods that share some resemblance to the 20-year period to 2000. They are: 1921 to 1929, and 1942-1966. 1921-1929 COMPARED TO 1980-2000 The 1914-18 war, known as the Great War, was the war to end all wars. It had relegated war to the status of an historical relic. The effects of winning World War I had a similar effect on the American psyche that the release of the Iranian hostages and the confidence in the future of America that Ronald Reagan was able to create. The year 1921 had a lot in common with 1981 in that post-war inflation was squeezed out of the economy, in a short sharp recession, enabling the boom of the 1920s to occur in a low inflationary environment. Like the 1980s and 1990s, nothing seemed impossible. The new technology of electricity, the automobile, and radio was transforming peoples lives in ways they could only imagine. They were so convinced that the panics of the past were as much historical relics, as war was, that they labeled their times, a New Era. The belief that nothing could go wrong gave rise to questionable business ethics and practices where the basic laws of economics were ignored in favor of simply making money by whatever means. They had their New Era bucket shops who sold stock that did not exist. We had our New Economy cyber pirates who talked up the price of stocks in order to make money off unsuspecting investors. As the 1920s wore on, and it seemed so easy to make money, few people cared that some of the new businesses based on electricity, the assembly line, and the new communication medium of radio had unsound business plans. In the 1990s, the euphoria over the Internet caused otherwise sensible people to buy stocks in new dot-com businesses that set up web sites, but were not even sure what they were going to sell on them. Both eras were fueled by a belief in the power of technology to create permanent prosperity and Utopian living, regardless of the fundamentals of individual businesses or the inflated level of stock prices. 1920s COMPARED TO 1990s By now, you may be thinking that because the 1920s were so similar in mood to the 1980s and 1990s that the next decade has to look like the 1930s. Would that prediction was that simple! The only thing we can be sure of is that the next decade will not be an identical twin, but we can use some parts of past models to construct our model for the future. So, to continue the comparison. Though the 1980s did not begin with a conventional military victory, that Reagan obtained the release of the Iranian hostages and raised optimism that the Cold War would soon be over created a mood of building a better world, which made it acceptable to risk causing a recession, in order to squeeze the inflation out of the economy, making 1981 comparable to 1921. Then, in 1989, the Berlin Wall came down, for which there is no exact past comparison. The Cold War was over and America had won. For the first time in its over 200 year history, America was the sole world superpower, similar to Britain until World War II, or similar to ancient Rome 2000 years ago. The feeling of superiority and invulnerability was palpable. Francis Fukuyamas The End of History and the Last Man stated, in essence, that the Cold War had been a war of ideas. American ideas had won and communist ideas had lost. It was therefore only a matter of time, he said, before the entire world adopted the American system of government and her principles of freedom. It became an instant best seller. Although Europeans felt tremendous excitement at the fall of the Berlin Wall, for much of the Cold War they had been bystanders, hoping desperately that neither America nor the USSR would do anything to start a nuclear war, which would be largely fought on their territory. Hence, though Europeans felt relief and empathy towards their newly-freed Eastern neighbors, there was none of the feeling of justification by heaven for their system of government and way of life that pervaded America after 1989. A feeling that was multiplied by the precision bombing and declared victory of the war against Iraq in 1991. The euphoric mood in the US during the early 1990s began to match that of the 1920s. During the 1980s, as the possibility of a nuclear war became less of a threat, the Internet, which had originally been designed so that military commanders in the field could communicate with headquarters, was expanded to allow limited civilian use, mainly by those involved in defense research or indirectly with military operations. After 1989, the Internet was released for civilian use. But it was not until 1993 that the World Wide Web, as we now know it, began to become part of our general consciousness. And, by 1994, the potential of the commercial uses for the Internet began to be realized. If you look at the 70-year chart of the Dow (Figure 19.1), you will see that 1994 was the year that the trend line of the Average became much steeper. Had the Internet been just a new technology, it is probable that it would not have caused this acute increase in the incline of the trend line. But, by 1994, the cumulative effect of first the great Communicator Reagan giving Americans back their pride, lost during Vietnam, followed by the victory of the Cold War, and Desert Storm, gave the Internet an almost religious significance to a growing audience. Americans had won the Cold War. It was only a matter of time before her ideals of egalitarianism and freedom became globally accepted as self-evident truths, and the Internet would be the Holy Place where the spirit of liberty and equality could flourish and be proselytized. There was nothing ethically or morally wrong with this attitude. It was just that it was a too simplistic and naive reading of the events of the 1980s and early 1900s, which in turn caused the unrealistic expectations of what the Internet as technology, as opposed to Internet as religion, could accomplish in the economic sphere. The rest, as they say, is history. The bubble burst in early 2000, and, for over a year before the World Trade Center attack, markets had been trending downward. Therefore, if any comparison can be made between 1929-42 and 2000-10, it is to point out that the period 1929-32 will not replicate this time around, even if a few similarities occur. From 1929 until the low in 1932, government did everything wrong. Had they have just stayed out of the way, it is likely, after the initial panic that took the Dow from 381 to 200, that after a short rally the market would have trended slowly sideways to down to about 100 over a period of maybe 5 years. This in turn would have been a lot less destructive to the economic infrastructure of the country. But Herbert Hoover was a stubborn ideologue, who thought he had the answers to the nations problems and by sheer force of will persuaded the Federal Reserve, Congress, and industrial leaders to take action, which made an already shaky situation much worse. But, before I compare the rest of the 1930s to the period to 2010, I wish to make one other comparison with the past. 1950s AND 1960s COMPARED TO 1990s Like the end of the Cold War, at the end of World War II, a great deal of technology, developed to fight the war, was released for civilian use. But World War II was very different to the Cold War in that Americans were forced to make sacrifices. Rationing was instituted. The men were shipped out, while the women manned the factories. And though, after Pearl Harbor, the war was not fought on American soil, the entire country was aware that war has a price, and in this instance a price that had to be paid. When war was over, the GIs returned to build a better world at home. But, there was not that feeling of entitlement or invulnerability that occurred after the end of the Cold War, a war in which Americans had not been asked to sacrifice. For this reason, while the mood was optimistic during the 1950s, it was not irrationally so. And the Korean War, which took up much of the 1950s, constantly reminded Americans that, though they had beaten Hitler, another potential threat was rising. By the late 1950s, the technology from World War II had been absorbed into the economy, and there seemed nothing new on the horizon to keep the economy moving upwards. Apparently, the USSR sensed this slowing in the US, and they installed missiles, pointing at the US, in Cuba. But Kennedy faced down the Soviets, first in Cuba and then in Berlin, when the Wall was erected, which restored American confidence sufficiently to carry the stock market up to its 1966 high. In addition to the confidence inspired by Kennedys actions, some major new technology was coming on stream that helped fuel the rise. That of electronics and transistors. Towards the end of the 1960s, this new technology created an irrational exuberance, akin to that which the Internet caused. And a similar result occurred in 1969, 1970, when many new high-tech companies lost much of their value, while some went out of business. But, the 1960s were a lot more complicated than the 1990s. In 1966, the Vietnam War began, and the new technology, which enabled war for the first time to be beamed into civilian living rooms, made it a highly unpopular war. The only way government could pacify an angry electorate and continue to fight a war, which Linden Johnson, as big an ideologue as Warren Harding had been, believed needed to be fought, was to prove to the public that this war would not ask them to sacrifice. It was his guns and butter policy, more than the Arab oil embargo in 1973, that caused the double-digit inflation of the 1970s. If low inflation had been maintained throughout the 1960s, the economy would have been able to more or less ride out the oil crisis, with moderate inflationary damage. But, by 1973, the money supply was already so out of control that the OPEC jolt simply exacerbated an already inflationary situation. So how do the 1960s compare with where we are at the beginning of 2002? There are some similarities, as well as some big differences. Like the latter part of the 1960s, the Federal Reserve has, for the last 2 years, been pumping huge amounts of what is euphemistically called liquidity into the system. The difference has been in consumer sentiment. Since the collapse of the overvalued market in early 2000, the Fed cut interest rates more aggressively than was done in the late 1960s. But, the impact on the stock market and the economy was almost nil during the year of non-stop cuts. Yet, in the late 1960s, pump priming drove the Dow back up to its 1966 high, both in 1968 and again in 1973. Why the difference? In the 1960s and 1970s, consumers were willing to spend with abandon. Since early 2000, this has not been the case. Therefore, it is also probably safe to say that, between 2002 and 2010, we will not see the kind of double-digit inflation that we saw during the 1970s because, even if the Fed cuts interest rates to zero, consumers cant be forced to spend more. Inflation does not occur just because the rates at which the consumer can borrow money are low. Inflation will occur when, as a result of low interest rates, consumers shop till they drop and increase their debt exposure. So far, that has not happened. And the September 11, 2001 attack has dampened consumer desire to spend further. A POSSIBLE MODEL FOR THE FUTURE By now, you should realize that although the next few years will have some similarities with the 1930s and the 1970s, it wont be an exact replica of either of them. The roaring twenties public, who had bought stocks with abandon up until 1929, never did come back into the market during the 1930s. That doesnt mean that the 1930s were a period of unmitigated economic gloom and bear markets. They werent. There was a sizable bull market from 1932-37, when the Dow increased 268% over a 5-year period. But, it exhibited none of the froth or exuberance of the late 1920s. Likewise, in the 16 years from 1966 to 1982; although the Dow never did manage to better its 1966 high, there were four mama-size bull markets, with tops in 1968, 1973, 1979, and 1981. But none of these bull markets compared with that which ended in 1966. The swinging sixties investor was either wiped out by the fall in their high-tech stocks by 1969, or they decided to use their money in other areas. They werent buying stocks during the 1970s. I therefore have no quarrel with my fellow advisors who predict a new bull market in the fairly near future. My only quarrel is with those who suggest that any new bull market will merely be a resumption of the late great bull market of the last 10 years. The irrationally exuberant 1990s are over. The New Economy investors have been wiped out, scared out of the market, or are still grimly holding on in hopes the market will come back. The latter will only sell out when/if they need the money for other things. And, in fact, there never was a New Economy. That was a catchy phrase used to run stock prices up beyond their real values. There is sufficient damage to the infrastructure of the economy, both in the US and abroad, that it cannot be resolved in a V bottom leading to a resumption of the uptrend, as some are predicting. The US economy was already in a bear market and a shallow recession before September 11, 2001. And previously, for at least two prior years, the more high-flying high-tech companies had been going out of business. We may indeed be in the early stages of the most globally synchronized depression since the 1930s, as The Economist stated in its August 25, 2001 edition, but it will not look like either the 1930s or the 1970s. Yet, it will have similarities to both eras. TO SUM UP Prediction is an inexact science at best. And more difficult than predicting where the market will go is trying to guess when it will do it. So, its brazen to forecast in a book. But, in my view, problems in world stock markets and global economies, barring a miracle, will not be resolved before well into 2003. And dont rule out 2005 as a long shot. There will be hefty secondary rallies in market averages, and a new mini-bull market or two. But, it will not be a resumption of the old bubble uptrend. The next 2 years plus will be a market of stocks, not a stock market. There will be a large number of individual stocks that will enjoy healthy growth, but the idea that one can buy most anything and forget about it, and it will go up, a la the last 10 years, is well and truly past. Buy and hold is history. My best guess for the earliest beginning of the next great bull market, of the sort we saw in the 1920s, 1950s and 1960s, or the 1980s and 1990s, is around 2005. WILL THIS BE A DEFLATIONARY OR INFLATIONARY PERIOD? Because of government interference in markets, this is difficult to judge at this stage. But, my best prediction is that it will be less deflationary than the 1930s, but not as inflationary as the 1970s. That assumes, of course, that OPEC and other oil producers wont suddenly decide to force up the price of oil. Though, as of this writing, it seems likely that any price increase they may manage to manipulate will be minor and have little effect on the overall inflation rate in the short term. In a worst case scenario, high single-digit inflation is not out of the question, but more would require an unforeseen event that, as of this writing, is not on the horizon. But, other things can cause inflation to rise. If consumer confidence suddenly returned, that could push price inflation up fairly quickly. WAR ON TERRORISM IS THE KEY How the war against terrorism plays out will be a major key, not only because of the cost of military hardware to fight a war, but because this kind of war affects the publics willingness to take risk. And, until or unless there is a clearcut victory against terrorism of the sort we saw in 1989 when the Berlin Wall came down, it is unlikely that the former irrational exuberance for stocks will return for ages. To oversimplify, I believe we are entering a period of economic and stock price erosion, akin to but not the same as that which existed in the 1930s and the 1970s: a period of multi-year duration. But within what can be called a major bear market, there will be substantial mini-bull markets. In order to survive and prosper during the next few years, you need to remain flexible, nimble and ever watchful, and cynical. Take nothing for granted and never forget that any model of future market action is an evolving one. What is 100% true on Tuesday may need to be modified by Friday. Constantly update your thinking and reexamine your premises for why you took a positionlong or shortin a particular security. And always remember the old Wall Street adage: When in doubt, get out. |
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