Thursday, August 30, 2007

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.

12 comments:

Unknown said...

Foreecon - I appreciate your classically trained analysis of this situation - though here's what I'm seeing. You are missing a bigger picture of the market.

From my 'classically' trained eye from my sector (Information Technology). You are using a chart that is starting from the mid 20th for historical data. I feel that the investor market probably changed in the early 80's due largely in part to my sector.

I mention this because you talk frequently in the positing regarding "type of investors". If you look at when the information flow to the investors (roughly 1980) - you see that the dynamic, of not only the graph, but the market changed completely.

You are suggesting that in historical terms it is time to prepare for a downfall. With this pessimism, I say "Boo" with a positive point. It seems that you are swaying toward this without the factual changes in the investor themselves. Starting with the personal computing boom (1980's) to the internet boom (1990's). Investors are now MORE informed than ever before, and can be much more confident in their decisions.

Thusly, I suggest, that human situations like panic, and fear, are not so widely spread across the entire market, and are minimal. I say this because the investors, though they may pull out, will only do so from a particular sector, or even temporarily to buy time or to transition into other markets.

I would like to hear more analysis regarding the volume fluctuations from sector to sector as a "dent" occurs.

On a side note - Thank you for your exclusive posting on my behalf, though I hope "diventually" there will be more posting from the other readers...I know I'm not the only Foreecon subscriber.

Unknown said...

An afterthought from my prior post...

I guess it's safe that I don't need to make the comparison of the day trading phenomenon of present vs. that of yesteryear...and however small or large, its effects on the historical data.

Disposable Info said...

You made some very good points:

"Investors are now more informed than ever before, and can be much more confident in their decisions."

and

"investors, though they may pull out, will only do so from a particular sector, or even temporarily to buy time or to transition into other markets."

As you've correctly assumed, people's panic-ability doesn't cause them to exit the market and stash their cash under their bed, they just switch from stocks to treasurys, for one - as I mentioned in my other post (They buttpile into treasurys, to be precise...)

However, because people are intelligent, greedy, a little panicky and are the "new type of high-tech investor," they'll convert their holdings from 2%-dividend-paying, precipitously-falling-stocks INTO a 5% no-risk treasury.

They'll do this BECAUSE they're the new type of investor - e.g. if we had low dividends and high PE ratios in 1987, the fall would have been shockingly worse than it was...

---

I think your ultimate point is that modern investors will largely sit tight and ride out and major "big money-driven" drops in the stock market. The implications, though, of assuming that they'll sit tight are that they are long-term, calm investors with monetary reasons to be that way (such as barriers to trading like commissions and trading fees).

My contention, that you might not agree with, is that they've got small trading fees, are intelligent and at least slightly panicky, and know exactly where to put their money in case of an emergency: out of the stock market and into safer, higher yield bonds.

Virtual Props,
-Dave

Anonymous said...

Finally! A blog worth reading.

Burgess said...

I'm smarter just for having read your blog and all the comments therein. Thanks. Just what a desperate housewife like me needs, a little stimulation.

Burgess said...

P.S. Please don't ever read my blog, I will be so embarassed. After reading yours, I am sufficiently ashamed of my stupidity, I don't need you to confirm it.
Thanks. :)

Disposable Info said...

...I think being obsessed with stocks and economics doesn't qualify these last couple of posts as "intelligent."

More likely, it makes anyone not interested in the subjects but who still takes the time to read them as understanding, kind and open-minded, at the worst.

You guys are awesome, and I hope you'll keep reading - In fact, Zane, you might appreciate a post I did a couple of weeks ago about why The Beatles suck (relatively), as you clearly have some strong musical tastes (Which I'm pretty sure I agree with quite a bit...)

Keep in touch,
- Dave

Anonymous said...

I did in fact read your Beatles post and I couldn't agree more with it. Specifically the point that nobody really likes the Beatles but still feels obligated to buy their albums.

I am interested in these topics but grossly uninformed. I look forward to my new education.

No pressure.

Unknown said...

Zane - just do what I do...talk out your butt, and put it into terms that makes sense...all the economist speak is just syntax - money is money, that's it...plus, you'd be surprised how far you can actually talk out your butt and realize that you might actually have some insight...

Did you not see my comments using aluminum foil? That's a perfect example...I know aluminum foil...even if I'm not grand master stock trader...and yet, it worked.

Okay - truth be told - don't give Dave the duty as teacher, then it will go to his head...keep him with antagonist...the writing is much more interesting.

Disposable Info said...

HA!

That's a damn good point Fred, and reasonably useful -

I imagine a scenario in which nobody argues with me... I would end up, gradually, assuming that my often arbitrary and sometimes misguided explanations of things are perfectly understood and agreed with, and after awhile I'd be spouting uninteresting jibberish with extreme confidence.

On the other hand, if the entirety of my feedback is debate, I'll explain too slowly and be overly obvious, which I've already shown some hefty signs of doing in these first few posts. That's because I've been trying to choose reasonably controversial topics and also I usually assume, in my head, that I'm arguing with people that don't agree with any of my points, let alone the larger ones.

The real trick is self-moderation; a little bit of arrogance mixed with trust and respect for anyone who might take the time to read this crappola.
...Now if only I could get even remotely close to achieving that...

Boy, I can't seem to stop at two paragraphs...

Anyways, I think Zane's strategy - a well-tempered and socially intelligent one - is to be kind and develop a rapport before the antagonizing can take over and serve its true purpose.

I would be utterly overjoyed if we could rope Zane into some philosophical, political, musical or even economic debate.

So don't rush 'im, I'm sure he'll develop the Fred-style skepticism of Dave's excessive, over-the-top, mind-boggling arrogance in time. :)

Props!
-Dave

Unknown said...

you mean "...mind-blogging arrogance!"

Disposable Info said...

Yeah, that's the one!