I was on the website MSN Money Friday night and came across an article title "Where Have All The Investors Gone?" written by staff columnist Anthony Mirhaydari. Unable to resist a headline like that, I clicked on the article. The general premise of Mirhaydari's argument is that there are fewer market participants today than in 1999, and this suggests that the financial crisis destroyed the faith of the "common Joe" investors in the stock market, and this somehow implies that the American stock market (NYSEARCA:SPY) is in the midst of a "Long Ice Age."
After years of stomach-churning volatility, scandals, bubbles and the rise of market-manipulating trading computers, American investors have had enough. They're choosing to park their cash in bonds, despite returns that in many cases don't even match inflation. What money they have in stocks sits uncomfortably in bland and broad index funds -- investments you make because you lack options, not because you're hopeful. Thus, we're in the midst of a long ice age for stocks -- a deep freeze not unlike the long sideways scrambles seen during the Great Depression and World War II. The market can't get healthy if people don't want to play... More broadly, we just don't trust the market.It wasn't that long ago, after all, when average folks buzzed about how stocks were enriching their 401k's, and workers looked forward to retiring early. Now we long for real pensions and hope we don't get involuntarily retired. That's a sea change. And it's reflected in the data.
First off, I disagree with the premise of his argument. The fact that the Dow Jones (DJI) and the S&P 500 have gone up over the past six months with so-called fewer market participants ought to offer evidence that stock market trading volume is not in and of itself a determinant of stock market performance - it's whether or not the people participating are willing to pay higher prices or not that counts.
Additionally, I don't agree with the statement "What money they have in stocks sits uncomfortably in bland and broad index funds - investments you make because you lack options, not because you're hopeful." When you don't have faith in something, you don't put money into it. Every $100 you put into an S&P 500 index fund buys you $3.57 worth of Apple (NASDAQ:AAPL), $3.37 worth of Exxon-Mobil (NYSE:XOM), $1.91 worth of IBM, $1.66 worth of General Electric (NYSE:GE), and so on. The adjective "uncomfortably" has little to do with the argument - whether you're comfortable about your 100 shares of Wells Fargo (NYSE:WFC) or not the stock exchange doesn't differentiate between the happy, sad, angry, or optimistic owner of 100 shares.
That's part of why I find it troubling that Mirhaydari says that stock indices are proof of "lack of options." If anything, I see it as a special form of courage and patience to ignore one's own big-eyed appetites and opt to hold index funds for an extended period of time. What if there's a doctor out there who generates $50,000 in discretionary income per year to invest, and has little inclination to study the stock market so he decides to invest his money in a collection of index funds to earn the market rate of return? That's not an example of someone miffed with his options, but rather, someone with a clear set of personal goals and the self-awareness to know how to meet them. In a market with millions of participants, it is dangerous to engage in sweeping generalizations about why someone owns something.
But my chief objection to this article is the assumption that stocks will be in a prolonged "Ice Age" because of market psychology - people aren't bragging at cocktail parties about their 401(k) balance, the market's not healthy, the volume is down, etc. This thought process grants disproportionate influence to investor psychology at the expense of what ultimately determines stock prices in the long run-earnings. Vanguard Founder John Bogle routinely told this story to sum up the stock market; he explained that what happens in America is that stocks tend to grow at 7-10% per year over time and investors are willing to pay about $15 for each share of those earnings on average.
So if PepsiCo (NYSE:PEP) generates $4 in earnings per share, people are going to pay about $60 or so to lay claim to those earnings (obviously this story is simplified - companies with higher growth rates tend to demand higher premiums, and vice versa). On average, companies like Pepsi will generate $4.30 per share the following year, and because each share now represents more profits, people will generally be willing to pay more (Nota Bene: This does not happen linearly, but rather, this is what can happen "smoothed out" over time).
There's a certain "tail wagging the dog" element to Mirhaydari's analysis, and I think it conflates symptoms with causes. While investor psychology has an impact on prices in the short-run, it becomes increasingly irrelevant in the long-run. Sometimes people will say things like: "Microsoft (NASDAQ:MSFT) traded near $60 in 2000, now it trades at $30. What more proof do you need that the stock market is broken?" Such sentiments ignore what I consider to be far more important than worrying about investor psychology: the pursuit of the greatest amount of future profits at the lowest risk-adjusted price.
When someone bought a share of Microsoft in 2000, every $100 invested represented $1.46 in earnings, none of which was paid out as dividends. Nowadays, every $100 invested in Microsoft represents $8.96 worth of earnings, of which $2.66 would come to you in the form of dividends. All else being equal, the $100 worth of Microsoft stock that I buy today gives me a far larger claim to profits than the same investment a decade ago.
This is why I reject the notion that stocks are in some kind of ice age - the pricing in the stock market today seems to be about on par with the historical norm-some stocks appear cheap, and some appear pricey. You can pay 18x earnings for shares of Altria (NYSE:MO), which Value Line predicts will grow earnings per share at 6% annually over the medium-term. Or you can pay 14x earnings for shares of Becton-Dickinson (NYSE:BDX), which Value Line predicts will grow earnings per share at 10.5% annually over the medium-term. The choice is yours. But as for me, I'm not going to make an investment based on whether or not the volume is high, the talk at the water cooler is or is not "confident", or because others don't consider the stock market "healthy."
I'm going to focus on finding companies that generate steady profits, have healthy balance sheets, and growing dividends. I won't hesitate to buy when I can get a price that gives me an 8-10% earnings yield and a 3-4% initial dividend yield, regardless of the investor psychology distractions going on around me.