Why is the stock market still so high?
We have seen an unprecedented debacle on the
. We have witnessed a year of a profits depression -- not a recession, a depression -- with no quick end in sight for many sectors. Why, then, is the price-to-earnings multiple of the
about 26, roughly twice the historic norm for periods of prosperity? Why is the P/E multiple of the
still so high after the tech bloodletting?
Why are stocks yielding on an earnings basis about two-thirds of what bonds yield when the usual ratio is far closer to identical? Why do people want stocks so much when the dividend yield on stocks is below 2%, or less than a third of what corporate bonds are paying?
The answer has to be that investors believe they will make more money with stocks than with bonds. And the reason people think stocks will make money is that over long periods, stocks always yield more than bonds or cash -- or so investors have been taught. Famous folks like James K. Glassman have taught us as much, and in the popular financial press, we read that total return for stocks almost always has eclipsed that for bonds.
But your humble servant, who could very well be mistaken, would like to offer some modest proposals about why those calculations no longer may apply to modern investing.
Start with this fact: To get to the calculation that stocks "always" outperform bonds and cash, you have to choose your start and stop points selectively.
Obviously, if you were all in cash in early March 2000, you would be far better off than if you were heavily into the Nasdaq, either on a managed or an index basis. The
, which tracks the Nasdaq 100, has fallen two-thirds from its high; cash, meanwhile, would have risen by roughly 7% in that time -- a swing of nearly 75 percentage points. The Dow has fallen about 11% from its all-time high in early 2000, so cash would have beaten stocks by nearly 20 percentage points.
You might well say that everyone already knows about the most recent misery. But take a look at some much longer periods. If you had been in the Dow from its high in 1929 onwards, it would have taken 25 years -- yes, 25 years! -- for it to regain the level it reached in 1929. Even with phenomenal wartime and postwar prosperity, it took the Dow from 1929 to 1954 to reach its late summer 1929 levels.
And, of course, there was inflation in that time. If you correct for inflation, in an approximate way, it took the Dow until at least 1989 -- 60 years! -- to reach its 1929 peak.
Or, you can look at it in more recent periods. The Dow approached 1000 as a close (and hit its intraday) in 1966. It took six years of high prosperity for it to reach 1000 again. In 1973, the Dow had a high close of 1052. It took nine years for the Dow to reach that level again -- meaning it stayed mostly range bound for 16 years, from 1966 to 1982.
My point is that contrary to the experience in the most recent decade, longer-term results often show that the stock market is not better than cash or bonds.
The alert reader will rightly say that this calculation omits the dividends that stocks paid. These have to be added into price movements to arrive at the total return of stocks. And in days of yore, the dividend yield was substantial. Often that yield exceeded the yield on bonds. The point was to compensate the stockholder for carrying the greater risk of price change and default than existed for high-grade bonds. If the yield on stocks was a net after defaults 6% or 7% -- and often it was more -- the return on stocks doubled within 10 or 12 years even if prices stagnated. Even into the early '80s, high-grade stocks were yielding about 5% in dividends.
That is ancient history and this is a brave new world. Driven by tax concerns and empire building, corporate chieftains retain earnings, supposedly using them more effectively than stockholders would. Thus, stock dividend yields on the Nasdaq are close to nil, and even on the Dow are barely at 2%.
Now, any gains that come from stock ownership in general have to come from capital-gains growth. Calculations from earlier in the 20th century that include dividends at a high level are irrelevant now. If stocks remain stuck where they are or fall, scant addition to total yield will come from dividends.
Then why do investors -- including yours truly, who certainly owns stocks -- continue to allow stocks to remain at such a high level? I think it has to be that last giant bubble -- and specifically a deluded hope that the bubble will return soon.
The '90s were the psychedelic era for stocks. There is no precedent for their return in most of our lifetimes. But we still keep hoping that the bubble will return -- and
Philip DeMuth, the noted investment psychologist, puts it in a thought-provoking way. As DeMuth sees it, investors who lost big in the tech debacle often cannot bring themselves to sell because that would mean final recognition of their folly in getting in on the wrong side of that bubble. Not only that, but if they sold after colossal losses and the stocks did by some miracle rebound, they would be suicidal. Thus, they refrain from selling because of a combination of fear that they will be wrong again and denial of the finality of the end of the bubble.
Through the prisms of fear or just plain self-delusion, investors see hope and keep on buying -- a hold is the same as a buy, as Roy Ash taught me long ago -- and the market stays at startlingly high levels relative to historic norms. Unless the law of reversion to the mean has been repealed -- always a risky bet -- these investors, myself included, are likely to feel more pain.
Then again, I could be wrong.
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Benjamin J. Stein has been a trial lawyer, a White House speechwriter for former Presidents Nixon and Ford and a campaign speechwriter for Reagan. He has been a columnist for
The Wall Street Journal
and written for publications including
magazine. He is a novelist, a nonfiction book writer and a screenwriter, and he has been an expert witness on financial fraud. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. At time of publication, Stein had no positions in the stocks mentioned in this column, although positions can change at any time. While Stein cannot provide investment advice or recommendations, he invites you to send your feedback to