The Elbert Files: Down or up? Let history decide
Friday, July 20, 2012 7:00 AM
One of my favorite 1960s’ books was Richard Fariña’s “Been Down So Long it Looks Like Up to Me.”
It was a coming-of-age novel. Today the title is about the only thing I still recall. It comes to mind whenever the stock market gets stuck below the curve, as it is now.
In times like these, I worry that my nest egg is turning into a goose egg.
But a recent article by Iowa-born economist Jim Paulsen gives me hope. The article is titled “Could ‘Confidence’ Add 50 Percent to the Stock Market?”
Paulsen is chief investment strategist at Wells Capital Management Inc. in Minneapolis. His investment newsletters provide historical perspective to market trends.
His July newsletter draws parallels between the current stock market slump and slumps that occurred during the late 1940s and again between the early 1970s and late 1980s.
During all three periods, Paulsen wrote, stock market prices failed to keep pace with corporate profits. The reason, he said, was a lack of economic confidence.
The causes were different in all three cases. But the result was always the same. Annual stock market gains fell below the typical 7 percent average.
In the late 1940s, the lack of confidence was “driven by a post-war inflation surge,” Paulsen said. During the 1970s, he said, escalating inflation and interest rates lowered stock values.
Today, the cause is “persistent anxieties surrounding the potential for a global financial calamity.”
Nobody knows when the current lack of confidence will end. It could be two more years. It could be five. Heck, it could be 10 or more, as it was the last time things got this far out of whack.
The good news is that when the stock market finally comes out of one of these prolonged slumps, the gains are substantial.
For the period following the 1970s and ‘80s slump, the substantial gains lasted several years, once the market finally took off in the mid-1990s.
Granted, there were other factors at work in each case. But there is no denying that economic confidence coincides with above-average market gains.
Paulsen shows that in his newsletter by overlaying a consumer confidence chart on one that shows how much market averages are above or below the average annual gain of 7 percent.
“Although not a perfect relationship,” he said, “the level of confidence has done a good job tracing changes” in earnings trends during the post-war period.
There’s also a long-term relationship between corporate profits and market gains. There has to be. If there were not, you’d have to believe the market was corrupt. But the relationship isn’t immediate. There’s typically some lag, especially on the upside.
That’s what is happening now. Corporate profits, Paulsen wrote, have already returned to their long-term, trendline average of 7 percent. But the stock market has not.
One reason the market has not rebounded is the nation’s aging demographics, which act as a brake on the system. Paulsen suggested, however, that the developing global economy could release the brake.
Several nations “are on the cusp of becoming burgeoning middle class economies, which should dramatically boost global demand” which could help spur the U.S. economy, he said.
The newsletter concluded with this thought: Following the gloomy times of the post-war period and the 1970s and ‘80s, stock prices were driven to fire-sale levels.
“Stock prices will continue to oscillate and scary sell-offs will occasionally feed fears, but don’t miss this sale,” he said.
I say: Been down so long it looks like up to me.
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