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Measuring when "it" is over | ||
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By DAVID MOON, Moon Capital Management,
LLC 'When do you think it will be over?'
That is the question of the year. Like the weather, everyone talks about it, but no one can do anything to affect it. Clients, friends, other investment professionals, my wife, even my 8-year-old kids want to know when it will be over.
To discuss the question, however, we must agree on the definition of 'it.'
Is 'it' the economy or the stock market? They are not the same thing. Stock prices do eventually reflect economic reality, but in the short-term, stock prices can move in reaction to practically any factor, whether it's rational or not.
When the Dow Jones Industrial Average closed at 8,835 early last week, it sat at the exact level it did on June 12, 1998. The capital appreciation return for the stock market was zero over this 10-year period.
Despite the economic malaise of the last 12 months, however, the economy did grow over the past decade. Gross Domestic Product, the measurement of the amount of goods and services produced in the country, increased 30 percent during those 10 years of flat stock prices (1998 to now.)
This isn't the first time something like this has happened ' not even in recent history. From 1966 to 1982 the Dow Jones Industrial Average also increased a net of zero points. On September 7, 1966 the index sat at 777, just as it did on August 12, 1982.
In spite of a recession during 1980-1982, the economy grew 51 percent during those 16 years ' a period in which the stock market was essentially flat.
How can that be?
Although stock prices tend to reflect the underlying fundamentals of a company, the correlation is neither perfect nor immediate. Investors try to anticipate changes in corporate earnings. When coming out of recession, the stock market has historically improved prior to the economy.
If you get out of stocks and wait for the economy to recover, you'll probably miss the boat.
Stocks can move drastically in a short period, which can impact the overall return for a longer measurement period. The DJIA has declined more than 40 percent in about the past 13 months. This wiped out the 60 percent increase of the previous nine years, resulting in a 10-year return of zero.
The beginning point matters. When you measure the percent change in something ' like the DJIA ' both your starting and ending measuring points are important. Changing either of them by only a few months can radically change your conclusions. You might be starting your measurement from either a grossly undervalued or overvalued level. If a person loses 50 pounds, would that make them skinny?
Not if they started their diet at 400 pounds.
The stock market has just suffered one of the worst 12-month periods on record. No one knows how it will perform over the next 10 years. But we do know a little something about the beginning point for that measurement.
We are clearly not starting from a historically overvalued level. David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).
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