.MONDAY. OCTOBER 21,1996 STOCK MARKET THE SALINA JOURM/fl. Experts offer five reasons for soaring stocky Economic growth, baby boomers' investments help spur the market By PETER PASSELL The New York Times Up, up, up it goes, and where it stops nobody knows. Since stock prices began climbing out of the trough of the 1990 recession, the Cow Jones industrial average has grown at 10 times the pace of the American economy. Perhaps as remarkable, investors have brushed aside every bit of troubling news — from interest rate increases to the defeat of an incumbent Republican president — with barely a hiccup. Not once in the past six years have stock prices fallen by as much as 10 percent. There are plenty of reasons the stock market should never have reached these dizzying heights: share prices are out of touch with underlying values, compared with earnings, dividend yields and almost every other measure. Other markets — commodities, real estate, European stocks — are far better buys. And so on. You've heard all the naysaying. Many a newspaper have repeatedly offered up the warning flags as the stock market continued its inexorable long march. Indeed, each new milestone in the upward trajectory has brought a number of undeniably smart — but so far mistaken — pessimists to the fore. And the rush beyond the 6,000 mark a mere 11 months after the Dow reached 5,000 is no exception. "We've passed through bullish into idolatry," allows James Grant, a longtime bear and editor of Grant's Interest Rate Observer. But successful Wall Streeters are nothing if not adaptable. More and more, bearish noises are being drowned out by the sounds of latter- day Panglosses explaining why this is the best of all possible worlds. They're pretty smart, too. And rich. So here are five plausible, even compelling, explanations for why it has paid so handsomely to take stock in America. The supersoft landing Once upon a time, there was a business cycle. On the way up, factories hummed, corporate profits rose and stock prices followed along happily. But as markets for labor, raw materials and key industrial goods tightened, inflation inevitably reared its ugly head. Just as inevitably, the Federal Reserve responded by raising interest rates. When profits were squeezed between higher borrowing costs and slackening sales, stock prices fell — in anticipation of the lean years that would follow the fat ones. Then the cycle started over again. But that's just an outdated fairy tale these days, isn't it? This time around, suggests Bruce Steinberg, an economist at Merrill Lynch, there is no big bad wolf at the door. As long as the economy keeps growing, all those little pigs who pour money into the stock market have a much greater chance of living a long life. "I don't think this is a complicated story," Steinberg said. "The economic expansion is already the third longest in American history, yet inflation remains very low." Indeed, after a brief scare last. summer, wages are rising only slightly faster than earlier. That's true even though unemployment is hovering just above 5 percent, a rate so low that workers should be demanding — and getting — big ; raises. But they aren't. ' And. with productivity up at least ' modestly, there is little pressure on ' companies to raise prices. That relieves the Fed of any immediate • obligation to increase interest rates and should eliminate the risk that tighter credit will push the economy into recession anytime soon. And there is no end in sight. Economic growth has slowed in • the second half of 1996, easing inflation pressures even further. While corporate profits are likely to be more modest next year, the prospect of what many call the "Goldilocks economy" — neither too hot nor too cold — promises to keep interest rates down, sustaining the current boom and justifying all the stock market euphoria. Still, opinions are not unanimous. Burton Malkiel, an econo- mist at Princeton University and the author of "A Random Walk Down Wall Street," is unconvinced that the recession genie has been securely contained. "A major shock — say, a war in the Persian Gulf— could still trigger a recession," he said. The baby boomers' gift The story fills the pages of every personal finance magazine: America's huge cohort of thirty- and forty-somethings is finally coming to grips with its mortality — or. at least, with the need to save in order to retire in style. And with study after study showing that the after-inflation return on stocks has been three times higher than the return on bonds over the long haul, those 76 million boomers are convinced they have little choice but to feed the raging bull. How else to explain the record increases, month after month, in money flowing into mutual funds? Moreover, there should be plenty of room left for buying. That's because Americans as a group hold only about 30 percent of their financial assets in stocks — less than they did in the 1960s and far less than most investment counselors advise. This would be a more convincing explanation for the stratospheric rise in stock values, if family savings had been plowed into stocks in the 1990s as much as all the advertising would have you believe. The problem, notes H. Bradlee Perry, former chairman of David L. Babson investment advisers, is that the numbers don't match the hype. While individuals have indeed been investing heavily in stock mutual funds through 401(k) plans, individual retirement accounts and the like, the additions have been offset by liquidation of directly owned shares. Indeed, from 1990 through 1995, stock liquidation apparently exceeded purchases by $51 billion. "People haven't been throwing money at the stock market in a mad frenzy," Perry said. But those numbers are open to question, particularly because a lot of the liquidation occurred as companies bought back their own shares or were taken over in mergers. Moreover, net purchases of stocks through mutual funds exceeded liquidation of directly owned shares by $53 billion in the first half of this year, perhaps helping to explain the last 1,000- point run-up in the Dow. Figures do lie A logical place to look for clues to equity values is in historical comparisons. The catch, said Abby Joseph Cohen, co-chairwoman of the investment policy committee at Goldman, Sachs, is that the standard benchmarks that suggest the market is overvalued are not good predictors of market performance. Take the ratio of dividends to stock prices, which is now less than 2 percent for the corporations in the Standard & Poor's 500- stock index. The old rule of thumb among traders is that yields below 3 percent are a sure signal to sell. But Cohen notes that five of the last eight times dividends have slipped below the magic number, stock prices have risen the next six months. Paul Samuelson, the Nobel Prize-winning economist at MIT, . dismisses the yield rule as a logical nonstarter. "Why should dividend rates mean much when there are good tax reasons to pay no dividends at all?" Another high-flying benchmark, the price-to-earnings ratio (now about 20 to 1) for the S&P 500, is seriously flawed. While the current figure is high by historical standards — it was well below 15 for most of the 1980s and stood at 22 on the eve of the crash in October 1987 — Cohen is not impressed. Earnings "quality" varies sharply with inflation because it Jllka Furniture regrets that, due to a printer error, the sale price for the Sealy Posturepedlc Exquisite Queen Set in today's Fall Festival of Mattress Savings Flyer should be 639 . We are sorry for any inconvenience this may have caused. is heavily influenced by artificial factors, like the value of inventories, in times of rising prices. And with inflation tightly controlled, she argues, current price-to-earnings ratios are not "troublesome." One number that has impressed academically oriented analysts is "Tobin's Q" — the ratio of stock prices to the replacement cost of the capital they represent. Named after its inventor, James Tobin, the Nobel economist at Yale University, Q measures market value by what it would cost to build the hard assets of a company from scratch. If Q is below 1, it is cheaper to buy productive capacity than to build it — an insight not lost on corporate raiders in the 1980s, when Q was as low as 0.6. But if Q is far above 1, it suggests that stocks are overvalued. From this perspective, stock prices are high. But that has been true for some time, and the market has risen anyway. According to Goldman, Sachs, Q for the S&P industrials broke above 1 in 1991 and is now between 1.4 and 1.5. Still, that is not dizzyingly high: Q touched 1.9 in 1965 and was above 1.5 for much of the 1960s. And there is a plausible argument why Q ought to rise over time because it fails to account for the increasing importance of short-lived and "intangible" capital — software, organizational skills and the like. "Q is a good place to begin the discussion of stock values," Cohen said, "but not a good place to end it." New times, new paradigms The stock market is not for coasters; if old rules don't work, move to new ones. David Shulman, the chief equity strategist for Salomon Brothers, should probably get the credit for the term "paradigm shift," now a stylish Wall Street phrase. In a report published in December 1995, Shulman abandoned his bearish stance, arguing that the bull market mirrors a fundamental change in expectations of inflation. But the idea that the book on stock market valuation needs to be rewritten has since acquired a lot more baggage. "Paradigm shift" has become shorthand for the case that high-flying stock prices reflect a recognition of the superior performance of the American brand of capitalism. "This economy has undergone a true renaissance," Cohen said, "and it's far from over." . Just why are investors in love with the new order? Cohen counts the ways. For starters, she said, there has been a "fundamental reversal in sentiment on fiscal policy." With big budget deficits no longer politically acceptable,. Washington will no longer compete with business for scarce capital. Already, the deficit has come down from 6 percent of the economy's output in 1992 to under 1.5 percent today. Add to this the fact that businesses have increased profitability by means that Cohen argues "go way beyond downsizing." The emphasis is now on return to capital, with far more attention paid to long-range goals. Corporations are bullet-proofing their balance sheets by reducing debt and increasing efficiency by investing heavily in technology. "It's striking," she said, "that the big boom in computer sales started during the last recession." Again, though, Malkiel is inclined to rain on the optimists' parade. For all the anecdotes about the more businesslike attitude of business, he said, "there is no evidence that measured productivity growth is recovering from terrible levels experienced since the mid- 1970s." Nor, he argues, is there good reason to believe that corporate profits will continue to outpace economic growth. Although the return to human capital is exceptionally high, the JILKA ICE CAPADES HOLLYWOOD STYLE! inunn .Toll Free M»-M»-SHOW Bicentennial All Seats Reserved $14.50 & $12.50 return to physical capital — the sort corporations own — shows no signs of a breakout. The greater fool theory There are myriad ways to justify owning stocks at this or that price. In the end, though, they all lead to the same place. Sooner or later — preferably sooner — the idea is to find someone who will buy the shares for more than you paid. The economist John Maynard Keynes likened the stock market to. a strange sort of contest that was popular in the British press in the 1930s. Pictures of a dozen attractive women were published and readers were asked to vote. The object, though, was not to pick the prettiest woman, but the one that other voters would pick as the prettiest. In the stock market, Keynes was suggesting, what counts is not intrinsic value but predicting what others consider valuable. The two may coincide. When they do, successful investors are congratulated for improving the "efficiency" of the market. When they don't, they are derided as speculators. But how to measure the degree to which "speculation" explains current stock prices? Perry, the former head of Babson, takes a stab. "Netscape fever" — the spectacular run-up of prices for stocks with little or no earnings history — has been the exception, not the rule, in recent years. And "the occasional excesses in various sectors have been quickly corrected," he said. That is certainly what happened to some of the high-fliers, like Iomega, that have been so popular on the hip Internet bulletin boards, like "The Motley Fool." Robert Shiller of Yale offers a novel approach to investigating the motives of investors: He asks them. Of course, you can't expect many stock market plungers to classify themselves as speculators. But among the questions that Shiller posed to institutional and individual investors, one amounted to just that. He asked if the following was true or false: "Although I expect a substantial drop in stock prices ultimately, L advise being relatively heavily invested in stocks for the time being because I think prices are likely to rise for a while." Among institutional investors polled, the percentage answering "true" rose steadily until very recently, nearly tripling from the fall of 1994 to the spring of 1996. But since then, the percentage has fallen. Perhaps the long-term bears have seen the light from the paradigm shift and now expect prices to rise as far as the eye can see — or perhaps they have simply succumbed to mass hysteria. Shiller's more limited poll of individual investors with substantial portfolios is equally intriguing. In the fall of 1994, with the Dow at 2,500, some 44 percent of these investors answered "true." By last month, it rose to 54 percent. "The fact that more than half those polled believed the market was overvalued, yet still had a way to go before it fell, has to RALPH WEIGH Bonds - Insurance Phone 827-2906 115 East Iron mean something," Shiller argueSr f? Deja vu-doo economics -% But what exactly does it meaflg Plainly this is not October 1929: when run-of-the-mill investment trusts — the equivalent of to'daj&j closed-end mutual funds — weti selling for two or three times tip value of the stocks they owned aft| betting on stocks had become tKe national pastime. £: Or maybe, just maybe, it is:*! few days before panic set in, PsK fessor Irving Fisher of Yale, tnl greatest economist of his era, _aift> nounced that he expected "to sfe the stock market a good deal higjjv- er than it is today within a few months." H THEATRES For MOVIE Selections and SHOWTIMES Call: 825-91O5 We've gone world wide web! www.dfckinsonthealres.com WALLPAPER BLOWOUT! DOUBLE ROLL (Over a thousand rolls on sale) ALL CURRENT IN STOCK PATTERNS NOW 1/2 OFF REGULAR PRICE! ABILENE Starvin Marvin's Floor Store...And More 108 NW 3rd (Downtown) • (913) 263-4491 We believe the public is sick and Died of candidates who resort to mudslinging and attack campaigning. This type of behavior is exactly what gives politics a bad name. Unfortunately, desperate attempts are being deployed to smear Senator Vidricksen's voting record and his integrity. Political ads full ot distortions, untruths, and innuendos have recently surfaced in the 24th State Senate District race. We have been told this is only the "Tip of the Iceberg." The committee to re-elect Senator Vidricksen will not respond with personal attacks and dishonorable tactics; however, we will telj the truth and set the record straight! Misrepresenting the facts to try to win an office of public trust is depiora_bLe and irresponsible. Senator Ben doesn't gperajte that way! AL SCHWAN Campaign Chairman CAROL D'ALBINI Campaign Coordinator Pol Aclv paid lor by Vidricksen lor Senate - Mary Liny, Treasurer. Bfe-Ete®t Slate Representative Carol Edward Do YOU like more money In your pocket? Or Do YOU want the bureaucracy spending your money? Over the past two years, Republican Carol Edward Beggs has voted to: • Lower our property tax mill levy • Lower new construction taxes • Lower vehicle taxes m ** **** * Vote Carol Edward Beggs... Out of Adv. Paid for by Beggs for State Representative • Adley E. Johnson, Treasurer.
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