Posted on 04/17/2003 10:54:17 PM PDT by JohnHuang2
Does the stock market hate both war and peace? Nearly everyone had been saying stocks were depressed by war uncertainties that would vanish with victory, bringing a huge victory rally. Why didn't that happen?
Sure, it will take several months to get Iraq oil back on the market. Meanwhile, the U.S. government has unwisely decided not to fill that void with strategic reserves. Sure, there are still big uncertainties about the costs and dangers of occupation. But two of the biggest uncertainties have, in fact, been resolved -- namely, the duration and damage of war itself and the risk that Iraq's oil fields might be seriously damaged.
A new study available at nber.org, "What Do Financial Markets Think of War in Iraq?" concludes that "war lowers the value of U.S. equities by around 15 percent." Professors Leigh, Wolfers and Zitzewiz even offer lukewarm tips: "War is bad for consumer discretionary industries, airlines, finance and information technology." It seems to follow that winning the war should have raised U.S. stocks by 15 percent, but that hasn't happened. There was more involved than war jitters.
This is the third year in a row when pundits tried to blame weak stocks on touchy investor psychology. Last summer, the stock market was said to be depressed because previous corporate scandals had caused a loss of investor confidence. After President Bush got behind the Sarbanes-Oxley accounting bill, however, the Dow fell 400 points in two days. Stocks have yet to regain the level that existed before the government kindly offered to restore our confidence in federal regulation.
In 2001, the favorite theory was that the market was down because a bubble had burst. Stocks were down because they had been up. This is a remarkably unsophisticated theory of financial markets, which may explain its popularity at the International Monetary Fund. The IMF estimated that a $10 rise in oil prices would cut U.S. economic growth by 0.6 percent. Yet now that oil prices have fallen about $10, the IMF reduced its forecast of U.S. economic growth. Those who always insist on being gloomy about the United States naturally prefer psychological to logical explanations.
All recent efforts to explain low stock prices by mood swings are logically equivalent to asserting that corporate earnings are fine, it is just prices that are low. Whether they know it or not, those blaming low stock prices on attitudes and emotions are asserting that the ratio of stock prices to earnings (the p-e ratio) is much too low. That assumption is hidden, but not necessarily wrong. Bearish complaints that the p-e ratio is "above its historical average" are meaningless, because that is to be expected when interest rates are far below their historical average.
To find out if an unduly depressed p-e ratio is really the reason stocks are so cheap, it helps flip the price-earnings ratio upside down. Doing that makes the inverted earnings-price ratio comparable to an interest rate. For S&P 500 stocks, the resulting earnings-price ratio was 3.18 at the end of last year, based on earnings over the previous year. In 1999, when we were supposedly near the end of a huge bubble, the earnings yield was almost identical -- 3.17.
Since the relationship between stock prices and earnings was unchanged, the entire drop in S&P 500 stocks since 1999 was due to lower earnings. There is nothing left to explain. That casts considerable doubt on the notion that there was some inexplicable "bubble" in 1999 (aside from NASDAQ).
Interest rates, however, are lower today than in 1999. The e-p ratio is normally a shade below the yield on 10-year Treasuries, which dropped from 5.65 percent in 1999 to 4 percent at the end of last year. So the1999 market may have been a little too optimistic and/or the current market may be a little too pessimistic. Still, the psychology has not changed that much. What changed were earnings.
The only way to break that link between lower earnings and lower stock prices is to claim reported earnings are not exaggerated (as Congressional reformers claimed last year), but understated. And one way to justify that curious claim is to use the government's profit figures. By that measure, after-tax profits first fell from $542 billion in the fourth quarter of 1999 to $429 billion in the fourth quarter of 2001, but then rose 10 percent to $473 billion by the fourth quarter of 2002.
Such prominent economists as Alan Greenspan and Art Laffer have suggested these government's profit figures are more accurate than corporate reports. The Commerce Department subtracts the actual cost of exercised employee stock options from profits, for example, and adds it to employee pay. Accurate of not, federal profit estimates tell us nothing about the earnings that matter for stocks. Federal figures cover nearly 6,000 corporations (including farms) -- few of which have publicly traded stock. And, as the study mentioned earlier pointed out, "publicly traded firms tend to be more cyclically sensitive than others."
Putting undue emphasis on investor psychology allows both optimists and pessimists to say investors are nuts. To say the market is grossly undervalued today or that it was irrationally exuberant in 1996 simply means anyone making such statements claims to be wiser than the rest of us. It may seem easy to assert that investors are an irrational, moody bunch, making foolish investment decisions for foolish reasons. But the evidence says markets are wise and it is the second-guessers who are nuts.
Earnings for the S&P 500 peaked at 13.74 cents a share on March 31, 2000. At the end of last year, earnings per share were down to 3.41 cents a share -- a drop of 75 percent from the peak, even though the S&P index was down "only" 41 percent. The fourth quarter was likely a fluke, with war risks pushing energy costs up and profits down. Unit costs of labor rose 3.8 percent while prices rose only 1.2 percent. Companies will produce and hire more when it becomes profitable to do so. Then stocks will rise.
©2003 Creators Syndicate
I, for one, find it extremely depressing that the Republicans own the executive and legislative branches yet can't seem to get even a small tax cut through. If they can't do it, what hope is there for a tax cut ever?
I'll drink to that!!!
I've been watching what insiders are doing on Vickers Stock Research at www.argusgroup.com and for awhile during the past few weeks they were really buying. Now that the war has slowed, they seem to be slacking off again. Is that what you mean?
The UN doesn't own any CARRIER BATTLE GROUPS, therefore, we (the US) can buy all the IRAQI OIL and tell the UNITED NATIONS to F#@k Off.
There are all kinds of possibilities.
I'll let you in on a secret. Republicans in Congress...and the Executive branch... want larger government. They need taxes to run that government. But even that won't stop them. They will borrow even more money...creating a larger deficit...that gets added to the debt...that we tax payers will be obligated for the rest of lives to pay. And for what??? Our president is a Republican, and I sure don't see him reducing government. In fact, he and our Congress are on a spending spree...just take a look at the deficit numbers. You cut taxes after government spends LESS than it takes in. Our leaders...Democrat...and Republican will never...NEVER...do that...until we make them!
They can't seem to get their heads out long enough to there is light at the end of the tunnel
I would love to move some money out of safe accounts and invest more, but I'm waiting for Wall street to chill it's nerves a bit .. they are all over the place
What the fang-bearing Democrats don't realize is that they have now set a precedent for future confirmation of all judges. Presumably, and as early as 2004, the Democrats will return to the White House. When that happens, the next Democrat President will be equally hard pressed to get his nominees to the bench.
I think the future is bright for Republicans, and America, over the next several years. The Democrats have to defend more Senate seats in the next election. And we've discovered that the old war horses don't like being in the minority, which could lead to earlier than planned retirements.
I would caution against being over-optimistic...I remember 1992. If the economy does not turn around, the next election could be very dicey.
Back to the topic: Whither the stock market? Beats the sh*t out of me. Unlike the pundits, at least I'm willing to admit that I don't have a clue. Having said that, I just have to believe that the foundation has been set for a stronger economy: historically low interest rates, lower marginal tax rates, and the prospect for stabler and lower energy prices.
I like the way you put it, Joe: One could argue it either way but that's the way it is.
TECH is waiting on several things to happen:
1) A legal solution to the "Napster" intellectual property questions. You say, "Well we had that." No, we had a ruling, but the SOLUTION is not yet present, and that is, how do you admit reality (that people are downloading stuff like mad) while simultaneously protecting some intellectual property? We came up with a good solution for movies and VCRs. The "content" aspect of the internet still awaits a legal solution that everyone accepts. When that occurs, there will be a new boom in content-related internet/computer functions and applications.
2) The "last mile" wiring issues also await a regulatory finality. Earlier this year, the FCC appears to have settled this. But whether or not the MARKETS accept that it is settled is, well, unsettled. Until the last mile is PROFITABLY wired, all the capability in the world in either computers (user) or the net (provider) are going to be meaningless, because there is no connection.
Think of it like this: we have super-speed "bullet trains," and we have lots of people who want to ride or ship things by train. But the bullet train stops 10 miles from your town, requiring you to either get a car, or provide other transportation to ship things to town. That somewhat negates the value of the train's speed. Further, let's say that much of the "equipment" that can be carried by the bullet train is too large to be shipped by truck the last 10 miles. Now the bullet train is nearly useless.
3) Venture capital. This is more an indicator than a cause, but VC in TECH has dried up. Sure, many were burned in the late 1990s, but there is usually money for a new idea. Not now. VC has thrived on UNPROVEN ideas. Now everyone wants a "business model" or some guaranteed profit. It won't happen---it never has. So to an extent, this, too, is psychological.
Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.