Como se combate o populismo? "Com eleições", responde Fukuyama

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The Five Key Reasons Not to Invest in Stocks in 2004

[Briefing.com - Dick Green] There were plenty of reasons not to invest in stocks this past year. Each was wrong. A review of these issues provides plenty of lessons for investors.

Beating the Inevitable Parade of Top Ten Lists of 2004 to the Punch
Below is our list of the most prominent bearish arguments from the past year.

Valuation is too high.
It is a jobless recovery.
Consumer spending is unsustainable.
The summer slowdown signalled the end.
Oil prices.
Despite all these worrisome issues, the S&P 500 index is up 6.8% year-to-date. Dividends have provided an additional return of 1.7%. That is a total return of approximately 8.5%. Not bad for a year in which there were so many reasons for the market to go down.

Valuation
At the start of the year, the price/earnings (P/E) multiple on the S&P 500 was 30. A couple of months prior to that, it was 36. Briefing.com received an endless stream of emails that said something like: Don't you realize the stock market can go down 50% and valuation will still be too high!

One of the most common mistakes investors make is to assume that valuation metrics, particularly the simplistic P/E measure, will quickly return to its long-term average through a correction in price.

This is wrong for two reasons. First, the correction in the P/E more often than not occurs because of a movement in the E rather than the P. In 2004, earnings growth surged. Some horrible quarterly numbers dropped out of the equation. As a result, the E portion of the P/E rose sharply enough to drive the P/E down to the current 21 even while the P rose.

This for individual stocks as well. A simplistic assumption that a high P/E means that prices will come down soon is often a recipe for disastrous investing.

Second, the P/E is a simple, static measure. In order to assess whether a P/E is too high or too low requires an assessment of other conditions, particularly interest rates. When interest rates are below their historical norms, P/Es will be above their historical norms. The low interest rate environment of 2004 supported the stock market at high P/Es as earnings rose sharply throughout the year.

The lesson for investors: don't expect the market (or a stock) to go down just because P/Es are high, or up because P/Es are low.

The Jobless Recovery
At its height in early 2004, it was used to explain why the extremely strong economic growth in late 2003 was simply a sugar rush from the tax cuts of 2003. In early January, December nonfarm payrolls were reported to have risen a statistically insignificant 1,000. Real GDP was rising at over a 4% annual rate.

It was clear, the pessimists said, that real GDP could not continue to grow without jobs growth. That meant that the stock market surge of late 2003 was unsustainable.

This was wrong for several reasons. First, jobs growth always lags in the economic cycle. This happens time after time after time. This cycle, the job growth pickup was even slower in getting started due to business caution. Second, companies pushed productivity before hiring to achieve further gains in output. This supported GDP growth.

This argument has long since died. Payrolls have risen 732,000 the past four months. That is an average of 183,000 per month, which translates to 1.7% annual growth in employment. Add in productivity of 2% to 3% and you have an economy growing at a real rate of over 4%. That is plenty of growth to sustain earnings growth and a rising stock market.

The lesson for investors: employment trends always lag the overall economic cycle. Don't expect every economic indicator to turn positive as soon as the business cycle turns, or for all of the economic data to march in unison.

Consumer Spending
One of the greatest fears of economists, politicians, and investors is that consumer spending will suddenly plunge. The consumer is the foundation of the US economy. Over the past few decades, consumer spending has risen at a steady pace with barely a break in the pattern. Yet, there is always some reason to fear a sudden downturn.

This past year, the big fear was that rising consumer spending was due solely to tax cuts and cash inflows from refinancings. A rise in mortgage rates would curtail refinancings and finally reveal the fragile nature of the US consumer (particularly in light of the jobless recover).

This simply proved wrong, just as many similar fears proved wrong over recent years. The steady increase in consumer spending was not due solely to this one factor. There has been a slowdown in refinancings, but no slowdown in consumer spending.

The lesson for investors: never bet against the US consumer. Also, never assume that a long-term trend will suddenly turn (or suddenly become important) just because it has become the fashion of debate. A current example of this is the argument that the decades-old trade deficit will suddenly crash the US economy just because everyone is now talking about it.

The Summer Slowdown
The stock market went nowhere from April to mid-August. Real GDP growth slowed to 3.3% in the second quarter and it appeared as if the slowdown might continue into the third quarter. Pessimists suggested that the stock market was on its last legs.

Part of this was due to the extreme negativism produced by partisan bickering ahead of the elections. Frankly, there were plenty of groups that preferred to emphasize the negatives, and even some that hoped for the worse. But the slowdown in real GDP growth still left growth above its long-term trend. And the flat stock market during the summer months was not only consistent with long-term trends, it was expected by Briefing.com and many others. It was hardly a reason for panic.

The lesson for investors: long-term investing requires sitting through some difficult periods. The market will not go up in a straight line. The same is true of the economy. There will always be downturns and negative economic or earnings news. It is a mistake to overreact to every little swing in the market or the data.

Oil
The rise in oil prices throughout 2004 was clearly a negative for the US economy and for the stock market. The impact just wasn't as bad as the pessimists had hoped.

When oil went over $55 a barrel, there were numerous articles about when it would create a recession. At $60? $80? Literally every single oil analyst we saw on TV said that oil would never go down again. Most of these people represented firms that were speculating in the oil futures. There was almost no contrary view.

Yet, while a rise in oil prices was a negative, few attempted to quantify it. Our view was that a $10 rise in the price of oil reduced GDP growth by about 1/2%. That is significant, but not the end of the world. There was also very little analysis about actually supply and demand conditions. Every time a pipeline leaked in Nigeria, speculators drove oil up another $3. But when the Saudis said they would pump more oil, analysts simply said it was insufficient and said something about demand rising next year without quantifying it.

Of course, oil prices have now receded and the impact to the US economy and the stock market has been kept in perspective. Fourth quarter real GDP growth will be near 4% despite higher oil prices. The stock market is now longer beholden to every more in oil prices.

The lesson for investors: everything changes and nothing is certain. (Which should be kept in mind regarding the current forecasts that the dollar has to go down, and down, and down).

What it All Means
There are always reasons to worry about the stock market. This year, the market climbed that wall of worry and looks likely to end with a return consistent with the long-term average of between 7% and 10%.

The underlying fundamentals of strong earnings growth, strong economic growth, and low interest rates provided further returns to investors.

The outlook for 2005 is similar. Earnings and economic growth will be strong. Unfortunately, interest rates are likely to rise, limiting stock market gains. None of that, of course, is certain. What is certain is that there will be plenty of analysts willing to talk about whatever bearish issue is the current fashion, and ready to explain why the stock market may soon crash.

There will be plenty of reasons not to invest in 2005, just as there were in 2004. We will help readers get through those issues as we did in 2004.

Dick Green, Briefing.com