The Market's Achilles Heel: Perpetual Growth

This may be hard to believe, but during the 70s, 80s, and into the early 90s, Wal-Mart Stores Inc.'s (WMT) stock was a juggernaut.

It was automatic. You bought it high, bought more on dips, and dollar-cost-averaged the rest of the time. An honest to goodness no-brainer. This was a stock you could confidently recommend to Grandma; a rock solid core holding for every client. No questions asked.

In early '93 I was watching Paul Kangas on the Nightly Business Report. He was doing one of those interviews with a money manager who would come back to the show from time-to-time. In his previous appearance the money manager mentioned they liked Wal-Mart. Paul pointed out it had done well since his last visit, and asked if investors should still be buying.

"No. We've sold our entire position."

I spewed whatever it was I was drinking all over the living room. The cameraman fainted. Paul Kangas looked at the guy as if he just cussed in church.

You don't SELL Wal-Mart... you BUY Wal-Mart!

Mr. Kangas is a consummate professional, thus he quickly regained his composure and asked his guest to explain.

"Paul, WalMart has been growing an average of 25% per year since the company went public. Their sales are quickly approaching $100 billion. We did the math and found if Wal-Mart continues to grow at 25%, their sales will equal the GDP of the United States of America by the year 2000. Frankly, we just don't think that's gonna happen."

It was one of those rare moments that offer crystal clear clarity. Anyone watching instantly knew he was right.

A few weeks later Wal-Mart came out with a warning that same-store sales would fall dramatically. More warnings would follow. Of course the stock was priced for perfection -- and owned by everyone and their grandmother, so the sickening slide was an absolute house of pain for several years.

I was reminded of that story today while listening to a very bullish market strategist. He not only expects double digit profit growth in '07, but found no reason we couldn't continue at the same clip for the foreseeable future (if you're uber bullish for '07 you can't allow for a slower rate of growth in '08 because we all know the market is a discounting mechanism).

The Achilles Heel of this market, ironically, is the simple law of large numbers.

Reversion to the mean.

The U.S. economy is somewhere in the neighborhood of $13 trillion, and has been growing about 3% per year during the recovery. Meanwhile, profits are up double-digits umpteen quarters in-a-row.

We currently enjoy full employment, relatively low interest rates, high productivity, and corporate profit margins that are the envy of the world. The U.S. economy has also benefitted from a staggering amount of deficit spending since the recession that followed the popping of the bubble.

It sounds great because it is great. In fact, it is phenomenal.

Until you do the math.

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