Email from a listener, Deb:
Listening to Phil Friday and heard Wayne Allen Root and Phil discussing Wayne’s prediction of the stock market crashing soon in the fall because it’s at an all-time high. Thought I would ask what you would say to Wayne if you were there.
Before I give my answer, let me provide a little background. They were talking about terrorism around the world and the stock market was just one portion of the conversation. The guest apparently felt strongly that investors were just sweeping risk of terrorist activity under the rug. Here is how I would have responded:
The market is always reaching all-time highs. In 1987 it reached 2000. In 1991 it was at 3000. 1995 it hit 4000 and hit 5000 later that year and on and on. Now the Dow is at 17,000. Through fits and starts it will hit 18, 19, 20, 21,000 and its moves up and down will be random. The movements will be based on the news that comes out. The news doesn’t have to be good, it just has to be better than what is expected for stocks to go up. If the news is worse than expected, then it will go down. That is the difficult part. You not only have to know what the news will be, you have to know, intimately, the exact expectations of all informed investors at any moment in time. I have a hard enough time truly defining what my expectations for the future are, let alone everyone else around me. We can probably safely say that stock prices went down significantly in 2002 because people expected that more terrorist attacks would occur right after 9/11. When attacks didn’t occur, we had a tremendous rally in 2003 that lasted for the next couple of years.
You might say that what the man meant was that prices were at record highs compared to earnings right now, but that would be far from true. Stock market investors price things based on what earnings are expected to be and, using that measure, the prices are right at historic norms. They are actually low or quite a bit lower than historically normal in many other markets around the world, but, as Americans, we tend to only look at one area of the market which is large US companies.
People seem to forget that the last several years have been fairly anemic economically, yet the market has been going up significantly from 2009 until now. What causes the market to go up isn’t just increasing sales or revenue from sales, but also decreasing expenses and company leaders have been getting very creative in reducing costs.
The market goes up three fourths of the time and down one fourth of the time. Someone predicting a downturn has a one and four shot of being right. If they are wrong, they hope everybody just forgets about it. If they are right, we never hear the end of it.
The reason for the downturn that the gentleman gave was terrorist activity. My guess is that he’s not the only person that recognizes the threat. Where some of those threats are the greatest, mainly in Europe, stock prices are significantly depressed already. Many European value companies, both large and small, are selling for less than book value – that is the accounting measure of the value of their assets minus their liabilities. To put that in perspective, the average price, historically, here in America is over $2.40 for every dollar of book value.
The gentleman was also talking about the Tulip Bulb Craze. I’ve spoken of that on many times on my show. Making such a comparison would be more closely related to gold, because tulip bulb prices are set by supply and demand and it is simply a commodity. By definition, commodities aren’t investments. An investment must be where someone is using your money and paying you for the use of it.
These types of crazes still go on. Gold prices skyrocketed when we had fears of economic collapse. When the collapse didn’t materialize, the price dropped.
