Is the Stock Market Really Dying?

Pessimism is often most widespread when a long period of economic troubles is nearing an end. What follows can be a surprisingly strong rebound.

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Richard Drew / AP

Traders Neil Catania, left, and Edward Curran work on the floor of the New York Stock Exchange, in New York on Aug. 8, 2012.

The American Theater has been declared near death so many times that Broadway has been nicknamed “The Fabulous Invalid.” Now the same sort of attitude seems to be developing toward the stock market. Smart commentators no longer view equities as the automatic safe choice for the core of a long-term portfolio. And many individual investors seem to agree. They are yanking money out of the stock market at the fastest rate since May. But just as there has never been anything wrong with the Broadway Theater that a hit show wouldn’t fix, there’s nothing wrong with stocks that can’t be fixed by an economic recovery and a fresh bull market.

Admittedly, there’s a lot to feel bad about nowadays – persistently high unemployment, devastated housing prices, and an economy growing at less than half the rate that’s normal following the end of a recession. Even worse, the stock market looks increasingly risky. The disastrous Facebook initial public offering burned many aggressive investors. And more recently, erratic computer trading has caused extraordinary short-term volatility in the prices of blue chips. So a somewhat downbeat outlook is understandable.

Today’s pessimism comes in a number of different forms, however. In his column “Watch Out for a Correction – or Worse,”  Mark Hulbert argues that the stock market has rallied over the past few months and that sentiment among traders and newsletter writers is now overly enthusiastic. But that’s just a warning about a possible pullback, not a negative assessment of the long-term prospects for equities.

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The Wall Street Journal’s Jason Zweig is more concerned about the erratic price swings caused by faulty computer trading. Recent volatility creates the “sense of markets spinning out of control and trading machinery going mad,” Zweig writes. And he adds, “The hearts of many small investors have been broken by the serial setbacks of the past few years.”

The most extreme view, however, may be that of Pimco’s Bill Gross, who compares today’s stock market to a Ponzi scheme. Corporate profits have been growing at the expense of workers’ incomes since the 1970s, says Gross, and that trend can’t go much further. As a result, stocks will be unable to provide the returns in the future that they have in the past. Belief in equities as long-term investments is dying, says Gross, “like a once bright green aspen turning to subtle shades of yellow then red in the Colorado fall.”

So can stock investors look forward only to falling leaves and broken hearts? That’s way too melancholy, in my opinion. Transient market volatility and the possibility of a short-term market correction have no effect at all on long-term returns. And Bill Gross’s argument that the long-term case for stocks has collapsed seems bizarre. Consider the following:

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Facebook is not the stock market. Financial journalists tend to focus on companies that are interesting to people who don’t necessarily invest. So there’s much coverage of social media and movie companies, but little about boring electric utilities unless a nuclear plant blows up. Yet retirement savers and other long-term investors should be buying utilities, not Facebook. And over the past two years, such high-yield stocks are up 16% to 20%.

This is an odd time to turn negative. It would be easier to understand an upsurge in pessimism in 2009 when the economy was tanking and the unemployment rate surged past the 10% mark. But now the worst appears to be over. However disappointing, the economy is slowly expanding. Moreover, those improvements are reflected in share prices – the S&P 500 has doubled from its 2009 low.

Stock returns average out in the long run. Growth in U.S. real GDP averages out to a fairly consistent rate over long periods of time. The profits of blue-chip corporations grow a bit faster. And share prices ultimately follow earnings trends. Gross’s argument that high stock returns are largely the result of corporations benefiting from stagnant wages ignores the fact that stocks also did well after World War II when unionized labor was claiming a bigger slice of the pie. In fact, stock returns have shown great long-term consistency for more than a century in all sorts of economic environments. There are decades when stocks perform badly, but eventually they make up the lost ground.

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Indeed, pessimism often reaches a climax not long before a troubled stock market finally hits bottom and then begins a major advance that lasts for a number of years. The classic example is the famous 1979 Businessweek cover story “The Death of Equities,” which came out less than three years before a massive bull market began. After 10 years of stagnation, the Dow tripled between 1982 and 1987.

There’s no guarantee, of course, that stocks are going to triple over the next five years, just because the past decade has been disappointing. But there are plenty of giant companies around with decent growth prospects, yields over 2.5% and P/Es below 16. For investors who aren’t trying to be wise-guy traders but just want to build their net worth over a period of decades, the case for owning those sorts of stocks looks just as strong as it’s ever been.

MORE: Every American Is Experiencing a Different Economy

17 comments
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TiSentinel65
TiSentinel65

To Clarify my comment. Factories in Japan and Many Axis nations were in no position to meet the needs of the populace immediately after WWII. They had a hard enough time feeding themselves.  The United States economy suffered  not a single bit. We were producing great ammounts products. The rest of the world needed our output.  When Japan's military leadership decided to Attack Pearl Harbor  Admiral Yammamoto warned of U.S.A.'s immense industrial might. He only guaranteed six months of success. Almost to the day the battle of Midway was fought and America's Industrial machine was swithcing to high gear. The Japanese could not match our ouput in anything. While american bombers ravaged the Axis industry,  ours was left unmolested. The Marshall plan set these countries up for success. He was very wise in steering Harry Truman towards its implementation.

ExecutiveOrder6102
ExecutiveOrder6102

Another Executive Order 6102 is on the way?

Obviously boosts productivity and the work force.

Daniel Morris

america1@usa.com

Dan Trudeau
Dan Trudeau

As the article points out, corporations have been growing at the expense of worker incomes.  This is the key weakness in our economy right now.  The government can't do much of anything to change this.  It's up to companies to start playing the long game and begin investing in their employees again for our economy to recover.  I don't know if this will occur anytime soon, though.  It goes against everything business schools have been teaching.

Bonnie K. Gregory
Bonnie K. Gregory

When you litterally destroy the competition,  your stock has only one way to go, that is up.  Poor choice of an example. http://KingofProfits.blogspot....

Little_Jack
Little_Jack

Not entirely accurate.  When one company grows at the expense of it's workers, it isn't a big deal.  However, when a whole lot of companies do it, they are literally undercutting their consumer base.  Whether you are one company among many in competition, or the "last man standing", you still need people to buy the products and/or services that you sell.  If they can't buy any, or have to cut back on the amount that they do buy, profits will shrink, regardless of whether or not you "destroyed the competition".  And if profits shrink, the stock goes in one direction.  Down.

Talendria
Talendria

The stock market has been bled dry by short sales, derivatives, and other unethical trading practices.  We need to curtail the activities of these creative traders because they're basically skimming from everyone's retirement account.  We need to go back to the paradigm of buying a stock and holding it for a minimum of two years, instead of buying a million stocks and selling them five minutes later for a two cent per share profit.  That kind of volatility destabilizes the market.

nmaxsw
nmaxsw

Nothing wrong with short sales....it keeps people honest.

GutboyBarrelhouse
GutboyBarrelhouse

 Hahahah. Clearly, nothing on Wall Street keeps people honest or can't be turned to corrupt practice. Even the regulators can't do it. An article  about why people are turning away from investing in stocks that doesn't mention the endemic fraud and negligence in the financial industry (Abacus, MF Global, Libor, "rogue traders", and on and on) is pretty silly.

TiSentinel65
TiSentinel65

The  reason stocks did so well after WWII was because the world had one choice. Buy U.S.A. or buy nothing at all.  The author omitted the fact that the European and Japanese economies were obliterated by  American bombers.  When you litterally destroy the competition,  your stock has only one way to go, that is up.  Poor choice of an example.

Jeeshman
Jeeshman

 "The  reason stocks did so well after WWII was because the world had one choice. Buy U.S.A. or buy nothing at all."

Wait, what?  Europe and Japan may have been obliterated (actually I'm not sure you can say Japan had been 'obliterated' with a few key exceptions), but they still retained manufacturing companies.  Companies in desperate need to rebuild.  The investment opportunity at the end of the war was *overseas* in rebuilding proven performers like Germany and the U.K.  "Buy U.S.A. or buy nothing at all" is entirely incorrect.

wandmdave
wandmdave

You make it sound as if the US started WWII and leveled all of Europe.  We couldn't help that Europe couldn't get its act together twice during the last century and Japan decided to attack our navy out of the blue. We just finished what those fools started.... and then gave them money to rebuild. They can thank us any time.

Jenny Hrvatska
Jenny Hrvatska

wandmdave, TiSentinel65 in no way made it sound as if the US started WWII.  They were merely explaining why the US was the only major industrial nation left standing after WWII.  It's possible to believe that the US was entirely right in all its actions in WWII and still believe this gave the US an incredible economic advantage post WWII.  The two positions are not mutually contradictory.

wandmdave
wandmdave

I agree with you but the way he or she worded it made it sound to me like American bombers were the only thing involved and thus we were to blame for the world being leveled. In reality Germany, Russia, France, Italy, and England all did a fine job of leveling each others' cities long before we arrived.  Even if we hadn't come along everyone with the potential exception of the Axis countries would have been leveled anyway. We were pretty much the only ones responsible for Japan's bombings but considering they conducted a surprise attack to pull us into the war that blame ought to be guiltless imo.

bsardi
bsardi

Yes, the Dow tripling, etc, but in context with the Federal Reserve propping it with money to create these bubbles.  If incomes of Americans are declining overall, and wealth is declining due to a collapse of home values, where is the base of money to invest?  The answer is that most investing is done by collectives (funds, retirement plans) but those must be based upon overall employment and the cost of living, which is rising at 10% per annum according to ShadowStats.com, not the target 2% the Federal Reserve indicates.  Any investment must yield 7-10% to break even.  Calpers, the California pension fund, has set 7% as its minimum target yield.  Your article extolled stocks that yield as low as 2.5%.  And let's not forget that the individual investor is operating in a casino against market makers, after-house shadow trading and fast electronic traders.  It would be financial suicide for an individual investor to try to swim in this lake of sharks.  What you risk when writing non-critical articles like these is making Time a non-reliable source for financial analysis.  And yes, Marc Faber, creator of the Gloom, Boom and Doom report, says there is always a false boom right before the doom.

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