Stony Brook finance professor Noah Smith briefly critiques Northwestern University professor Robert Gordon’s argument that “the golden days of growth are over” in a recent BloombergView post. Smith summarizes Gordon’s recent book as arguing that a few key technological inventions catapulted growth from 1870 to 1970, but that the low-hanging fruit is now gone and so growth has necessarily slowed. Smith makes two arguments and one additional background point in response. The background point is that the future of technology is, by its very nature, unknowable – there may or may not be great inventions around the corner. That aside, Smith argues that Gordon’s pessimism should be viewed in light of the difference between growth and life satisfaction, and with recognition that governance and other matters are also major contributors to growth (“technology isn’t the only thing that makes society better”). Due to the “decreasing marginal utility of wealth” and a corollary principle applicable to technology, we may have “the illusion of stagnation,” Smith suggests. That is, “inventions that take us from the brink of starvation to prosperity and security will seem more important than what comes after, even if both add the same to GDP.” Secondly, Smith highlights the importance of governance improvements, noting the contrast between North Korea and South Korea. He suggests that in developed countries the “quality of government . . . improved dramatically in the 19th and early 20th century,” which “was responsible for a significant amount of the growth” from 1870 to 1970. He suggests that, in evaluating Gordon’s argument, “we should consider the possibility that government quality, as much as technology, is what has stopped improving,” if only because key improvements have now become standard.
The Guru Investor
Mark Hulbert reports at Market Watch that, based on his survey, “the stock market timers with the best records are bullish, on balance, while those with the worst records are bearish.” He notes that this remains true when periods ranging from 12-months to 20-years are used to assess performance. Further, “since the stock market over [the last 12 months] has declined by about 10%, and turned in one of the worst Januarys in years, bearishly inclined market timers would have a distinct advantage,” but the best performers are currently bullish. Hulbert’s “best-versus-worst contrast” as a measure has mixed results in predicting the market. It was bullish when market fell 20% in 2011, but the best timers were more bearish than the worst just prior to the 2008 crisis. Chart below sourced from MarketWatch.com.
A Wall Street Journal blog post by Jason Zweig profiles “superstocks” and suggests they provide a “reason why, for most people, index funds make superior sense.” Zweig notes that 44 U.S. stocks have generated cumulative returns of 10,000% or more over the last 30 years, and borrows the term “superstock” from William Bernstein of Efficient Frontier Advisors to describe stocks that grew at least twice the rate of the S&P 500. David Salem of Windhorse Capital Management says of the companies, “they have all undergone at least one near-death experience.” Apple, Inc., for example, fell 79.6% between 1992 and 1997, underperforming the S&P 500 by 771%. As David Salem observes, “there are no investment professionals in the world who bought Apple 30 years ago and held it continuously ever since” because of that steep decline. This is why Zweig sees superstocks as a reason for most people to favor index funds: “when companies decline 50% to 80%, index funds won’t sell them . . . if some of those companies bounce back and turn into superstocks, index investors get to go along for the full upswing.”
Bill Miller of Legg Mason, a value investor with a strong record, told CNBC’s “Squawk Box” that it is “sort of hard to see why anyone would buy a 10-year Treasury when they could own the broader market at a higher current yield.” He sees “a disconnect between what’s really going on and what the markets are reacting to,” citing “strength in homebuilding,” “70% of companies are beating earnings estimates,” and other signs of a strong U.S. economy. Further, he stated a clear value position: “lower prices mean higher future rates of return.” Regarding oil, he commented: “historically, oil has had a negative 85% correlation with the stock market . . . and every recession since 1970 has been caused by higher oil prices, but today we have a 95-100% positive correlation . . . people make up a story to talk about that, [but] lower oil prices are unequivocally good for the U.S.” He also noted that “when the market hit its low, every major homebuilder [except one] was on the 52-week low list. Now I can assure you that nothing that’s going on in China is affecting homebuilders” and oil prices have little effect, providing further evidence that now is a good time to buy due to low valuations.
In his MarketWatch column, Mark Hulbert highlights the use of margin debt as a market indicator. Margin debt is the total amount investors borrow to purchase stocks. As Hulbert notes, research by Norman Fosback, former president of the Institute for Econometric Research, concludes that “a good long-term indicator can be created by comparing total margin debt with its 12-month moving average.” If the current level is above the 12-month moving average, it is considered a bullish indicator; if below, a bearish one. Fosback’s research suggests “an 85% probability that a bull market is in progress when the indicator is bullish, in contrast to only a 41% probability when the indicator is bearish.” The indicator appeared to work well in the 2007-09 bear market, but not as well in 2011. Currently, it has been sending bearish indicators for five straight months.
Liz Ann Sonders of Charles Schwab offered a cautiously bullish analysis of the market at the recent Inside ETFs conference. She cited Sir John Templeton’s statement that “bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.” She sees the current market in the “mature” phase of the bull cycle. “I don’t want to dismiss any of the concerns out there about the global economy, but if you look at the data, it’s not as bad as the doom-and-gloomers suggest,” she said, placing the risk of a U.S. recession at about 25%. Regarding China, she described herself as “in the soft-landing camp,” and suggested the risk to the U.S. is not large because of the minimal role exports to China play in U.S. GDP. She clearly stated the current market is “not another 2008,” describing it instead as possibly “another 1998 or 2011 based on market behavior.” She suggested the Fed is unlikely to tighten as rapidly as it had suggested, which portends well for the market in 2016. More broadly, she observed that “within secular bull markets, you can go through cyclical bear periods that have higher likelihoods of correction and volatility.” That is precisely where Sonders’ seems to believe we are now.
Financial Advisor reports on Wharton School of Finance Professor Jeremey Siegel’s comments at the annual Inside ETFs conference, where he critiqued the widely used Shiller P/E Ratio. Siegel did not necessarily attack the original logic of the Shiller P/E (which won its creator, Robert Shiller, a Nobel Prize). Instead, he noted that changes to the definition of generally accepted accounting principles (GAAP) earnings by Standard & Poor’s in 1990 have had an effect. Following the Financial Accounting Standards Board requirements, the GAAP change required mark-to-market accounting, which means companies mark down their assets when they have a loss but can only markup assets when they are sold.
Turning to the market, Siegel described himself as “the token bull.” He maintained that Fed policy is not “artificially inflating stocks” and we are not experiencing a new bubble. Nonetheless, he concurred with many observers that investors should expect lower returns going forward, but predicted about 5-5.7% real returns over the next decade. He cited slightly high valuations, slow economic growth, the risk aversion of an aging population, and a perplexing decline in productivity. On bonds, he predicted a bigger decline, with real returns around 1.0% to 1.5%.