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July 28, 2004 |
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When investor’s talk about the 1970s you rarely hear “you could have made a mint if you bought stocks in late 1974 and sold in the summer of 1976.” Instead, and borrowing a phrase from 1990s Japan, the 1970s stock market is exclusively talked about using ‘lost decade’ analogies.
Given that only 57% of mutual funds are stock or hybrid funds (the rest being focused on fixed income), the above statistics do not fully represent stock market participation levels (the SIA confirms that no decline in individual investors took place as of 2002). However, domestic equity fund flows are the most accurate indicator of capital participation.
When taking a closer look at the capital participation, notice how the outflows coincide with declining stock prices.
Despite the outflows in 2002, the fact is that inflows have dominated the bear market since 2000. The most logical explanation for participation rates remaining near their 2000 bull market peak during a multi-year bear market is that bull market mentality never died. In other words, whereas investors accepted that the 'good times' were over in 1929 and the 1970s, no such acceptance has come to pass today. Bucking History, The Herd Holds On Rather than argue that today’s average investor – who according to recent surveys still doesn’t know that you can lose money buying bonds – is patient/stubborn enough to hold stocks for life, a trip down memory lane might be helpful. Investment trusts (the mutual funds of the 1920s) attracted more new money in the first 10 months of 1929 than they attracted in the five previous years combined. Then, suddenly -- after the October crash - all of this money was staring at losses. New investors that purchased stocks for quick riches panicked and started selling, and selling, and selling. Lack of hard statistics notwithstanding (the investment trust numbers are from the NYT), the 1929 rally and subsequent bust demonstrated that investors will – a la the herd - buy into rallies and sell into sell offs. This phenomenon repeated itself in the 1970s, when more than 7 million shareholders left the marketplace following a massive increase in the participation rate in the 1950s and 1960s. Moreover, this phenomenon reared its head again, albeit to a significantly less dramatic extent, during the 2000-2002 bear market. Why Are Things Different This Time Around? Although it is impossible to arrive at definite conclusions, that investors have not fled stocks probably has a lot do with how long and profitable the 1982-2000 bull market was. Quite frankly, while there are other reasons for rising participation rates - including the ease of trade/research via the internet and lack of savings alternatives thanks Fed rate cuts - that stocks have come to be regarded as savings is the most convincing reason. Not only does explosive growth trends in retirement accounts (IRAs, 401Ks) back this theory, but the correlation between money market outflows ($81 billion in outflows in 2003) and stock market inflows also suggests that stocks have become the choice of savers. Regardless of whether or not investor’s regard their stock positions as savings, it would be naïve to argue that investor’s would not sell if they consistently lost money in stocks. And yes, despite a terrific bear market the word ‘if’ remains applicable today. To be sure, for the four years ended 1998 the investor’s average S&P 500 buying price was 793 (using mutual fund inflows and annual S&P 500 averages). The S&P 500 closed below this level only once (October 9, 2002).
As for the capital arriving in equity funds from 1999-2003, the average S&P 500 purchase price 1,118. And although this considerably higher than 793, this four year period represents less than 50% of the total capital invested in US equity funds since 1995. Accordingly, when combining/weighting these four year periods together you arrive an average S&P 500 purchase price of 989 since 1995, or lower than today. Point being, whereas new investors were quickly hit with brutal paper losses in 1929, and 1970s investors were stung by a decade of stock price stagnation, investor’s since 1995 (and earlier) are still, on average, holding profits. 1970s Recap The Dow began the go-go 60s at 679, toyed with 1,000 in early 1966, and closed the decade at 800. Suffice it to say, because of the lack of gains to be had in the 1970s market it did not take much to stymie and scare investors: a choppy range driven market pushed many loss ridden investors out of the markets with each sell off, and the rallies eventually ended in ruin. Even so, the liquidity trends in the 1970s were not the only item dictating investor sentiment trends. Rather, inflation in the 1970s - pushed up by primarily by OPEC and a weak US dollar – also helped destroy the bull market mentality that lived during the go-go 60s.
As you might suspect, as inflationary pressures ebbed stocks become more attractive. In the early 1980s a new bull market was born.
A 1970s Repeat? Even though many similarities can be made between the first four years of the 1970s and the first four years of the new millennium – the US dollar is weak, rising oil is making headlines, and stocks are overvalued by many historical measures – there is nonetheless a lack of pessimism in the marketplace. Quite frankly, a shakeout is required before any legitimate comparisons can emerge. When might this shakeout occur? Well, if history is going to continue repeating itself, very soon.
The markets - nearly four years into the new millennium – are weaker than they were at this point in the 1970s. However, during a vicious sell in the latter half of the year, US stocks hit decade lows in 1974. Will the fourth year of the new millennium see a repeat of 1974? It is easy, perhaps too easy, to draw comparisons to today’s market and 1974. However, baring a disruption in Saudi oil – what many refer to as ‘peak oil’ – the similarities do not appear able to last. Indeed, with too many central banks to mention eying rate increases, demand from China likely to slow, and many reports suggesting that growth in the US has already moderated, a dramatic spike in inflation appears unlikely. Even so, a weaker dollar remains a wildcard, and the government could be underestimating inflation in the CPI. The stagflation 70s – a rare period of slow growth and rising inflation – can be completely ruled out yet.
Conclusions Whereas the hoopla surrounding Google’s upcoming IPO is an example of [mini] bull market excitement, Business Week’s infamous ‘Death of Equities’ article, published August 13, 1979, is an excellent example of the lack of interest toward the end of the 1970s bear. “Even if the economic climate could be made right again for equity investment, it would take another massive promotional campaign to bring people back into the market. Yet the range of investment opportunities is so much wider now than in the 1950s that it is unlikely that the experience of two decades ago [the 1950s], when the number of equity investors increased by 250% in 15 years, could be repeated.” Business Week As it turned out, the 250% increase in equity investors wasn’t merely repeated, but blown away – since 1980 the number of US households that own mutual fund has increased by more 1,000%. The historical rule of declining participation rates during bear markets did not hold true during the recent/current bear market. Instead, investor’s held on to their positions. Thanks to this large shareholder base, the overly optimistic Kudlow’s have been awarded the right to tell investors what they want to hear a little bit longer. Thanks to this large shareholder base investor’s have remained deaf to what they need to hear: stocks are not savings. A repeat of the 1970s is unlikely baring an oil crisis, and a repeat of 1929 is unlikely baring a dollar catastrophe However, a repeat of 1982-2000 - by way of simple mathematics - isn’t just unlikely, but impossible. To be sure, many households in America don’t have any savings to put into stocks, and nearly 50% of households are already in the stock market game. Point being, while a bull market mentality exists in the markets today, the possibility of bull market liquidity rushing into stocks is not present. Thus, we are not in a new bull market, but waiting for the old bull to expire. While we wait, lest we forget the real ‘lost decade’…
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