You might think that someone who'd written a book entitled
would want to slink away into a corner somewhere and never speak to anyone again.
Recent Meet the Streets
Attorney, Cohen & Grigsby
UPENN Law School's
But that's not the case for James K. Glassman, who wrote just such a book, along with fellow economist Kevin Hassett, back in September 1999 (back then, the two predicted the
Dow Jones Industrial Average
could reach 36,000 by 2004). In fact, though, Glassman has just come out with a new book offering tips for investors, and although he stays away from making specific predictions about where he thinks the market will go from here, he does defend his and Hassett's original assertion.
Glassman's main thesis is that the riskiness of stocks relative to bonds has historically been overtimestimated, and that the markets are in the process of recalibrating themselves. While P/Es are high relative to historical levels, they should be still higher, Glassman maintains.
Here the American Enterprise Institute resident fellow defends his theory and points out some of the highlights of his new book,
The Secret Code of the Superior Investor
TSC: What say you now about the Dow 36,000?
, despite its somewhat inflammatory title, was a very sophisticated new theory for stock valuation. If stocks were properly valued, the Dow
be valued at roughly 36,000 today.
The reason stocks are not properly valued is very simple. A revaluation process, whereby investors began to wake up to the true value of stocks, began in 1982, when the Dow was at 777. The Dow will continue to grow, powerfully, with fits and starts, with room for bear markets.
But within a fairly short period of time, the Dow will get to this fully valued state. In 1999, I said that was a three-to-five year event. Now, obviously, that's not going to happen; I don't think we are going to see the Dow at 36,000 by the end of 2004. ... It may be by the end of this decade, stocks will be fully valued ... and we'll hit 36,000. And once that happens, stock returns will fall below the annual 11% average of the past 75 years, possibly to the same level of corporate profit growth, which has historically been the same as annual average GDP growth, in the 5%, 6% range.
TSC: So, why aren't stocks properly valued now, and what criteria do you use for valuing stocks? After all, P/E ratios are still at lofty levels compared to the past.
Very important question. The theory that undergirds our 36,000 prediction ... is there is a
of research that shows that over the long term, stocks are no more risky than bonds. Over the past 75 years, they have returned an annual average of 11%, whereas bonds have returned 5% -- roughly double.
Wharton economics professor Jeremy Siegel, in a 1995 book
Stocks in the Long Run
, wrote that the safest long-term investment has clearly been stocks and not bonds. "Safest" was his word. I don't like to use that word, but he's a pretty circumspect guy, and he said "safest."
So in economist terms, stocks have a very large risk premium. In other words, they are paying you for risk. But our argument is that that risk doesn't exist. We are not saying stocks are risk-less -- but what we are saying is that over the long term, the riskiness of a benchmark Treasury security, which is subject to the slings and arrows of outrageous inflation, is no more risky than stocks.
Investors, starting in the early 1980s, began to bid up the price of stocks and bid down the equity risk premium. Right now the process, we believe -- fellow economist Kevin Hassett and myself -- is halfway through. And when it's finished, the equity risk premium should be in the neighborhood of zero, maybe one
TSC: What is the equity risk premium now? And what will happen to stock prices if and when this falls to 1% or lower?
The equity risk premium is a hard number to calculate, but it's probably in the neighborhood of 3%. It used to be 7%.
What will happen when the equity risk premium goes lower? P/Es will go up because stock earnings yields will go down. And then there's no need for stocks to produce gigantic returns. Historically, stocks have returned 11%. What we are saying is, that's way, way, way too much.
Detractors have said to us, "Look, you may be right that it is perfectly reasonable for stock prices to be much higher than they are today, to reach 36,000. But the nature of investors is one of excitability and emotionalism, and when a bear market arrives ... people will change their mind about the riskiness of stocks and go back to their old ways."
We say, "You may be right. Let's get a test." We think that once people realize the truth about stocks, which is that they are undervalued, people will continue to buy more stocks.
Just look at the past two years. In 2000, when the Dow was down 5%, the
was down 9%, the
was down 39%, people put more than $300 billion in net new money into stock mutual funds. This past year, which was a devastating year for the stock market ... people again put more money into equity mutual funds, only $30 billion more, but still, they put more in than they took out. We think that is one very clear sign that we are right.
The second one is the one you bring up: P/E ratios. People have been wringing their hands over P/E ratios for months now. We say, "Yeah, look at those P/E ratios. They look like they're high." But they're not high -- and the reason is when you look at the riskiness of stocks vs. the returns of bonds, those P/E ratios should be
In fact, today's high P/Es validate our thesis. In a typical recession, they go down to 15 or lower. But not this time. Here we've got P/Es around 25. To a lot of people that's a sign the market is vastly overvalued. To us, that's just a validation of our theory.
Investors can believe that when they invest today, they are not buying overpriced stocks.
TSC: Given that there are so many high P/E stocks, particularly in the technology sector, stocks you believe some stocks are particularly undervalued?
Absolutely. I am a very strong proponent of buy-and-hold investing. In
, Kevin and I highlighted 15 stocks for a "Dow 36,000 Portfolio." From the time since that book was published, Sept. 1, 1999, through Dec. 31, 2001, that portfolio produced an average return of 8% -- which doesn't sound so great, but the S&P during the same period was down 12%. So, we beat the S&P by 20 percentage points. And the Nasdaq over this period was down 29%. So we beat the Nasdaq by 37 percentage points. Ten of those 15 stocks are up -- but I still wouldn't change a single stock.
I personally like
Automatic Data Processing
, which is a for-profit secondary school chain,
Johnson & Johnson
TSC: Are there any sectors you particularly like?
Pharmaceuticals and for-profit education.
TSC: One of the key points in your new book, The Secret Code of the Superior Investor, is to warn investors against buying the hype perpetuated by the financial media to promote the latest stock, in order to pump up viewership or readership. But wasn't your book, Dow 36,000 part of that very media circus, by its provocative title alone?
While we have been accused of being part of the excesses of the Internet era, our Dow 36,000 Portfolio, for instance, only had two technology stocks in it: Cisco and Microsoft. And while both those stocks are down in the 27 months since we created this "portfolio," I still like these companies because I still like their business models.
The Secret Code
takes readers through 10 top-line, plus 47 additional tips to become a "superior investor." Can you name some of the most essential ones?
You want to buy businesses, not stocks. Diversify, diversify, diversify. That's a lesson of
. And don't pay attention to the
the economy, stupid.
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