1. Archive

Maybe this time it really is different

To veterans who have been through bear markets, the scariest four words in investing are "This time it's different" (TTID). You've certainly heard one of your bullish friends say, "Yes, stocks are high, and, in another era, we'd be headed for a bad correction. But this time it's different."

Another word you hear from the TTID crowd in describing the current market is "unprecedented." Eugene Peroni, director of technical research at Janney Montgomery Scott Inc. in Philadelphia, recently said, "This market has unfailingly been able to defy mass consensus and historical precepts. It is simply an unprecedented market that's making historical inroads."

Why? Rationalizations are legion.

The most popular is demographics: Baby boomers, thinking about retirement at last, are throwing huge amounts of cash into stock mutual funds. Fund managers have to put this money to work right away, so, in their haste to buy, they bid up prices of stocks.

These are unprecedented times, the TTID folks figure. After all, the Dow Jones industrials haven't fallen 10 percent in six years _ while, on average, the Dow has taken a drop of that size in every 18-month period since 1900, according to James Stack, editor of InvesTech newsletter.

Stack also notes that the Dow has fallen at least 40 percent an average of every nine years, but we haven't had a decline of that size since 1974.

But investors with long memories believe that TTID reasoning is bunk. If stocks haven't fallen in a long time, they will _ and hard. It's never really different, but, just before a steep fall (or a protracted bear market), you keep hearing, over and over again, that it is.

Maybe I've become too irrationally exuberant myself, but I'm beginning to wonder whether the TTID advocates might be right.

It's simple: Stocks are overpriced. One indicator of a stock's value is the ratio of its price to its earnings _ or it's P/E. In other words, how many dollars does it take to buy a dollar of this year's profits? Right now, the average P/E ratio for the companies that compose the Standard & Poor's 500-stock index is 21, according to Bloomberg News. That's very high, especially at a time when earnings are strong. It compares with a P/E of 16 two years ago and just 8 in the early 1980s.

A second indicator is the average dividend yield for an S&P stock. Currently, it's 1.9 percent, down by one-third from two years ago. Yields have never been this low. The reason to worry is that the formula for yield is dividend (in dollars) divided by price. Dividends are a function of profits, so if profits are strong (as they are now) and yields are falling, then it means that prices are high _ maybe too high.

"Once upon a time," says James Solloway, a Wall Street analyst, "a yield of less than 3 percent was considered a sign of an extremely overvalued market. Even before the 1987 collapse, Solloway points out, "the dividend yield never fell below 3.2 percent."

Don't panic. My own TTID reasoning is that stocks are rising because companies and investors are both getting smarter. This time, it really might be different.

Take companies. More and more of them have learned that paying dividends, which emanate from after-tax dollars, is downright foolish. Instead of sending profits to investors, where they get taxed a second time, why not use them as capital to build the business? Or use them to buy back stock, thus increasing the value of shares that are outstanding?

It appears that this is just what is happening. Dow Theory Forecasts newsletter reports that, since 1991, the profits of S&P stocks have been growing nearly three times as fast as their dividends.

What about P/E ratios? Aren't investors paying too much for stocks? Again, maybe not. Over time, stocks have proven to be superb investments. Since 1805, they have produced average annual returns of about 8 percent in real terms, or 11 percent at today's inflation rate.

More important, research has found that, if investors hold stocks for 20 years or more, they are no more risky than government bonds or even Treasury bills.

Again, this has always been true, but is it possible that investors are finally waking up to the reality of stocks? Why buy a 30-year bond that pays 7 percent if a mutual fund (even after fees) will return 10 percent, in the long term, at no greater risk?

Investors are becoming smarter in other ways. They are making wiser allocations of assets in their retirement accounts. They have been buying on dips in the stock market.

The question comes down to whether investing intelligence is cumulative or cyclical. The bears believe it's the latter; I have an inkling that it may be the former.

Still, I am wary of other TTID arments. For instance, stock prices are clearly linked to profits. But, while corporations have certainly grown more efficient in their operations (thanks to both brains and high technology) and are selling more to a richer global market, it's unlikely that profits will continue to accelerate. Competition, remember, is global, too.