Fred said, "Molehill"

In response to Fred's comments, I figured I'd clarify some of my predictions and add in some others. First, let me simplify my rambling rant from the last post:

1. The dividend rate essentially lets us know how many people will hold their positions in stocks if there were to be any wide-spread panic. (There are other, more obvious, ways to measure this, but I had the graph in front of me.)

2. Panic occurs, I'm suggesting, in response to signals of reduced GDP growth, not full-on recessions or, as was the case in 2001-2003, increasing GDP by itself - The economy and companies' earnings were getting better throughout that time period, yet the S&P still fell 22%, so it's the type of investors that determine the price (PE levels) of stocks.

3. The type of investors that are (were) currently pushing stocks up to 20%+ overpriced territory are NOT the type of investors that will be sated with 1% to 2% dividends coupled with stock losses. Simply put, they'll get the fuck out of the market rather than sit around, accepting 2% returns on their investments (not including potentially huge losses from stocks).

and finally,
4. The point of mentioning the dividend "pops" was to show that companies recognize this fact, and thus will increase their dividends as soon as the "speculative" investor leaves town. So, logical conclusion: The lower the dividend rate, the greater number of speculative, greedy flakes pushing the market up to irrational levels - Since the dividend rate is currently "excessively" low, and the S&P is currently "excessively" high, chances are good that panic - caused by sooner-than-expected signals of slowing GDP growth - will lead to a drop in proportion to the drop of 2001-2002, as the dividend rate now is essentially the same.

The good argument here, which Fred brought up, is that there are some differences we should note: (I do like the metaphor, by the way):

It's like a sheet of aluminum foil - when it's spread thin, it's weak. A single dent hurts it a lot. But when you dent it enough, it turns into a ball that is strong enough to throw, impale, roll, bounce, mold, and even take more small dents - but the strength can't be taken away...without being spread thin again.

My assertion, however, is that the very thing that is spreading the market thin right now is the low dividend rate (among some other things). A robust market - or tight aluminum ball, if you will - is only created by the strength of the investors' resolve. Even if every person on earth had money in the stock market, the very fact that the majority of them are fearful creatures means the market can fall. In fact, the greater proportion of fearful, speculative investors you have in the market, the greater the ultimate fall, because almost everyone would be looking out for his or her individual best interest. The only investors that are strong enough to ignore stock prices and survive solely on dividend income are those that are in the market for dividend income. So, finally, one of the ways, I think, to figure out proportion of fearful individuals in the market is to look at the dividend rate. So, what proportion of investors do we suppose is satisfied with 2% dividends and zero (negative in the panic situation) stock growth?

However, as Fred implied, there are some other important differences:

The S&P PE ratio is much lower than it was in 2000, and there are many more investors (of a variety of "types") with more money than ever before. So the real question is, how much panic are we going to have, come slowing GDP signals, and how much damage is that panic really going to do? Considering the major difference between 2001 and 2007 (PE ratios mainly), we should expect LESS damage this time around, right?

Well, this is where I have to start getting technical. looking at the market from a wide, wide perspective, you'll notice something interesting:



The last 15 years have been pretty impressive. Although this isn't a logarithmic scale (adjusting for relative percentage growth) it more easily shows the periods of "trending" growth.
I've drawn some crappy lines on this one to show some of the more obvious long term trends:


The drawn-in brace is pretty presumptuous of me: I'm suggesting it is the difference between our current situation and a panic situation (not a fair-PE ratio situation, mind you, but a low PE situation - the result of underpricing, undervaluing stocks caused by wide-spread panic.) Such a situation should warrant two things: Instantly higher dividend offerings by companies, and the reemergence of rational investors of both the long-term type and the bargain-hunting type.

The point of the trends is that they represent the economy fairly accurately: If we zoom in, we'll see the micro-scale actions of companies, and micro-panics and speculative bubbles, and all that crap. In the aggregate though, economic growth warrants a consistent, moderate pace of corporate [earnings] growth, until major technological or sometimes mass migration-related shifts in the economy change the long-term pace of growth.

Examples:

From 1950 to 1982 - uniform, high rates of growth with no hugely spectacular changes in the economy.

From 1982 to 1995 - Computers, huge productivity increases.

From 1995 - 2007 - Globalization and communication advances, better computers, unbelievable increases in productivity due to the Internet and network-ability.

However, how do I know that the line I drew is not angled too low? Why don't we assume 2003 to 2007 is a "new era" in the rate of stock growth?

Well, three reasons:

1. There have been no shockingly significant changes to productivity over the past 4 years that weren't, at least in a lesser form, available in the late '90s.

2. Investors are nuts, or incredibly speculative, I mean. That's the whole point of all the dividend rate talk: Check my last post and look carefully at the inverse movements of the dividend rates and the S&P over the past 15 years. I'll bet you see a correlation - whether it's true or just a coincidence - between the lowering dividends and the speculative bubble of the late '90s.

3. Assume that we're having this conversation in the year 2000, as millions of people did. This is the graph they would be looking at:
We know that there were tons of financial analysts and economists that assumed the (trend line) growth from 1995 to 2000 was a result of the Internet / technology boom and therefore its steepness was warranted. It turned out they were wrong, and their guarantees of a "new economy" helped my parents and certain other people I know lose a lot of money. Of course, there were a lot of financial analysts and economists that knew the insane PE ratio - and even the dividend ratio - would pretty much guarantee a speculative-bubble bust, but who listens to Negative Nancies when everyone's makin' so much damn money just by throwing darts at the stock page in the Wall St. Journal?

So, let's summarize:

The difference between 2007 and 2000-2001 is that we've got relatively lower PE ratios now, but the dividend rate is basically the same. Honestly, as I was suggesting in the last post, the PE ratios could survive at the 20%+ over-historical-average prices they're at now - when we forecast faster growth, PE ratios rightly rise.

However, my ultimate point is still this:


Because of the amount of speculation - or, more importantly, speculative investors - we're going to fall back to long-term trends in growth (the 1995+ trend) before we, as a collective group of responsible investors, can "decide" to have a more representative and higher PE ratio (AKA a new, steeper trend line).

But as long as the majority of overly optimistic investors who concern themselves only with short- to medium- term equity growth (rather than long term, dividend and conservative fundamentals growth) are driving the price of the stock market, we'll have to face some pretty serious, and unnecessary, panic every time things get out of hand.

When? My guess: ANY TIME between now and October 2009. Mark my effin' words. When stocks do drop, it'll be down to the long term trend line. When that happens, make sure you're buying stocks - unless, of course, there's a much better reason not to (such as the rise of the machines, Terminator style...)

Don't forget, though, that between now and the time the next panic hits, you might be able to make great returns on stocks. As long as you pull out before the GDP starts signaling a decline, one would think (I would think) you'll be fine - Either that, or just buy some good index funds and ignore them for 40 years. That seems a lot easier than all this analysis, actually...

...And Fred - Thanks for participatin'. You're awesome - And "dividents" was pretty clever.