The Hour (CT), April 3, 2002
Knight-Ridder/Tribune Information Services, March 27, 2002
Westminster Journal, May 23, 2002
"If you're so rich, why aren't you smart?" That ought to be the question of the year for the big financial gurus, many of whom promoted stocks of companies like Enron, Global Crossing and other houses of cards right up to their collapse.
It's not like you had to be an accounting genius to see through some of the tricks these companies used: e.g. Enron counting the entire value of its energy trades as revenue, instead of just the commissions that they actually earned. But this raises a bigger question about the whole stock market bubble, and one that is still relevant: what do these people and companies that offer financial advice really know?
Millions of people who put their retirement savings in stocks within the past couple of years now find that they will be working longer, and retiring less comfortably than they had planned. Yet most of them were told by financial planners, not to mention the business pundits, that stocks were a sure bet -- at least for those who were holding for the long run.
But even now, with the S & P 500 off 25 percent from its peak, stocks are still highly overvalued by any historic measure. This means that the average person holding stocks today is almost certainly going to do very badly, if they are investing for the long term.
How can we know this? Well, over the long run, no one holds stocks just because they have faith in the future. At some point the companies have to deliver earnings that justify the prices of these stocks; otherwise investors will move into bonds and other assets, and the price of stocks will fall.
Right now the average stock has a price-to-earnings ratio that is about 23 to 1, even looking at pre-recession earnings. That's about 59 percent higher than the historic average of 14.5 to 1 over the last 75 years. In other words, the price of stocks -- relative to the earnings that the underlying companies are capable of producing -- is 59 percent higher than it used to be.
At present, no one has come up with a scenario for the economy that would explain how stocks could maintain such a high value relative to earnings, over the long run. At least, there is no scenario that is consistent with what economists are willing to believe is a plausible story about our economic future.
For example, today's stock prices might be sustainable if stocks were considerably less risky than they were in the past. So much less risky that people were willing to hold them for a real return of about 4.5 percent year, or not much more than they could get on a government bond. But who do you know that is investing in stocks for these kinds of returns?
Alternatively, stocks could be a good long-term investment if the economy were to grow twice as fast in the future as it did over the last 20 or 30 years. But you won't find anyone betting on that prospect.
All of this is arithmetic, and the numbers can be put on a spreadsheet. The interesting thing is that so few of the professionals seem to care whether their advice is consistent with what they know about the economy. When was the last time you heard a financial advisor even try to explain why he or she did not consider today's overpriced stock market to be a bubble?
Of course there are often severe conflicts of interests involved: for example, stock analysts promoted failing technology companies that generated fees for the Wall Street brokerage firms employing them. And if you are a mutual fund manager investing other people's money, there is an incentive to follow the herd. The conventional wisdom holds that you will be blamed if you miss out on a speculative run-up in stock prices while everyone else is riding it; and perhaps not burned so badly if your performance crashes along with everyone else's when the bubble bursts.
But these institutional failings can't explain why so many professionals advised buying into a bubble at its peak, nor the general lack of respect for logic and arithmetic. A nagging question remains: what do financial advisors really know?