We began last Saturday’s Reckoning with the thought that there are plenty of better opportunities to make money in the world than US stocks. That might sound strange. The S&P 500 was up 30% last year. It was a ‘Very Good Year’. And, for the record books, 2013 is just outside the top ten returns for US stocks in a calendar year since 1900. But the odds seem to suggest 2014 will prove a disappointment if you’re expecting a Very Good Year to happen again, in the US at least.
We say that because we have a book in our hand called It Was a Very Good Year: Extraordinary Moments in Stock Market History. The book goes back and profiles the best years of the last century looking for clues on what causes a Very Good Year. For the record, here’s the list:
We should point out the book was published in 1998. But the years above still stand as the best today, including the 16 years since It Was a Very Good Year came out. When reading older stock market books, it’s always fascinating to see how much changes, but also how much stays the same.
The way investors view stocks sure has not stayed the same. Take the way author Martin Fridson describes investor attitude to shares in 1915:
‘A contemporary reader of the early-twentieth-century financial press forms a distinct impression that in those days responsible investors regarded common stock as an inferior sort of bond. Expected growth in earnings wasn’t a primary focus of valuation, because price appreciation loomed small in people’s thinking…Journalists commonly equated the established dividend payout with the return on the stock, giving little thought to possible price appreciation. They compared the payout rate directly with bond yields.‘
Of course, we live in a very different monetary system today. But it did make us think twice when Diggers & Drillers resource analyst Jason Stevenson pointed out this week that his analysis shows the US stock market gained 30% on the back of less than 3% earnings and revenue growth last year. Or, to put it another way, the stock market went up 10x the earnings growth rate.
Actually, anyone who’s read It Was a Very Good Year might have expected something like this over the last few years. Fridson’s conclusion on the winning combination to look for when hunting for a Very Good Year looks interesting in the light of events since 2008. Here’s what he calls the ‘winning formula’: Depressed Prices + Sudden Credit Easing. Fridson:
‘Stock prices begin at a depressed level, reflecting fears that inflation-conscious central bankers will inflict more pain. Suddenly, a financial crisis reduces the price level to a secondary public policy consideration. As the Fed liquefies the system, the stock market quickly and radically adjusts to the changed circumstances. In their eagerness to prevent a meltdown, the monetary authorities unavoidably give stock investors a windfall.‘
Of course, from an investing perspective it’s all very well to say you should buy up big when prices are depressed, but oh so difficult when the world is screaming crisis and collapse every day. Being cynical about who politicians take care of when it comes to crunch might make the decision a bit easier next time. Fridson admits that the Fed merely poses as an independent body but is in reality hostage to the politics of the day. Basically, when it’s called upon to print money, it’ll print, consequences for the rest of us be damned. And this was in 1998. Think of the astonishing amounts of money pumped into the system since.
Suffice to say, if we take Fridson’s ‘winning formula’, it looks played out for now. The US has had five positive years. Mind you, there’s always the chance of a wildcard. The 1920’s saw consecutive Very Good Years in 1927-1928. Of course, if we tapped editor Vern Gowdie for an opinion at this point, he’d probably rightly point out investors also got 1929. In fact, he’s expecting a drop like that as we speak. You can see why here.
One reason is the level of margin debt in the US. That’s the money investors borrow to buy shares. It’s at record levels. You can see the numbers in Vern’s report. With interest rates in the US on the floor, there’s plenty of easy money floating around.
But the sixty four million dollar question is what will stop US shares in their tracks? We don’t know. But you won’t find suggestions for what to look for in the bull markets covered in It Was A Very Good Year. For that, we need to study the great bear markets. Stay tuned.
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