In stock market parlance a “correction” is a decrease in the price of a stock or group of stocks of 10% or more. This week the Dow has been flirting with a correction so I think it might be a good time to consider Steve Forbes’s “five basic reasons stocks are falling”. They are
- The U.S. Senate
- Misbehavior by the Fed
- The profit picture is getting blurry
- World economies are a mess
- The world security situation is worsening
I think an even more basic basic reason is that by what used to be the historic standards the relationship between stock prices and earning is incredibly out of whack. For 120 years the P/E ratio was around 15. Now it’s half again that.
Why? You can come up with any number of explanations but the implication of the (by historical standards) detachment of stock prices from the performance of the companies means that prices are unquestionably being buoyed by something else. If it’s “animal spirits”, I’d find an explanation of why the spirits of the stock market and those of entrepeneurs are so very far apart extremely interesting.
The Fed apparently decided to announce they will keep pumping, so expect stocks to level off until the next shock hits.
“If it’s “animal spiritsâ€, I’d find an explanation of why the spirits of the stock market and those of entrepeneurs are so very far apart extremely interesting.”
From my perspective it’s not that odd. But first, a note. The same easy money dynamic is at play in the illiquid equity market, with plentiful debt availability driving purchase multiples up, in round numbers, 30%-40%. In addition, the underfunded pensions and yield chase have created huge pools of capital that, because of the use it or lose it dynamic of PE funds, has driven up valuations. More Fed created problems. A discussion of risk adjusted returns is for another day.
As for entrepreneurs vs stock speculators, er, investors, the dynamics are so different. Whether you are a retail investor or Mr Goldman and Mr Sachs QE is dominating all other valuation issues. You can trade in and out on that news alone, and it’s been an upward bias for quite awhile now. You add in profits above average as companies behave like cash cows by not investing in new hires or equipment and you have explained the vast majority of it. Not to sat that an IS or Ebola issue cannot be a factor. Look at the airline stocks.
Now consider an entrepreneur, which I assume is defined as a small business owner or someone considering a start up. they can’t trade in and out based upon the Fed, and their businesses will be cash eaters if they attempt to grow. Now add in a number of headwinds – regulations, litigation risks, increasing costs to employ, regulatory and tax issues, and all decisions they make stick with them – no way to trade out. You are stuck in the investment. Is it any wonder an entrepreneur views the world differently than a stock market participant.
I’ve been trying to make people understand this point for years now here and OTB. All I get is some variant of “if you’d pay people like In N Out they would all be happy and run through walls for you” or ” entrepreneurs are crazed Reefer Madness types who will start up companies no matter what.” Super.
I don’t know what the situation is now but statistically most entrepeneurs used to be guys in their late 40s, early 50s—the much-despised “old white guys”.
The rate of formation of new businesses today is lower than it was during the recession of the early 80s, even lower than it was during the Great Recession of the 1930s.
Guys came back from the wars ( II or Korea) and either started a business or went to school/apprenticed and then started businesses. That’s pretty much your 75-85 yr old owners or their heirs. Then you naturally had the baby boomers just because of the volume of the bulge. ( It’s also where we get most of our leads. ). So many of these businesses were started in the 50s – 80s. Many of these guys will tell you they would not do it today because of the headwinds. In some cases it’s why they sell.
If you believe as I do that things like this don’t happen over night then it’s been a good 50 year process, probably taking root in the 60s.
The caveats are really three: 1) bill gates at al don’t give a whit about the headwinds, 2) I’m talking $30 – $200MM revenue businesses; it only gets worse for M&A and pa, 3) this is somewhat stylized.
But you are talking to a guy who is basically semi-retired in large measure because the headwinds I spoke of just make it un enjoyable and overly risky today. I’m sure others would disagree, but I and most small business owners I know find this administration particularly antagonistic. They have hunkered down.
That would be ma and pa
I didn’t really address your 40s – 50s comment. We of course see that. It tends to be fed up guys (with corporate life), business maturity and out of necessity like in recessions. Which makes a point about the prospects for success in the current environment.
Suppose you bought a stock once upon a time for $100 and what you got in dividends was 7 bucks per year. So your payoff was 7%, justifying your roughly 15/1 price-to-earnings figure. But most of the 20th century, even in good times, you were staring at a 2% inflation rate, or higher. So you were actually making 5% on your hundred buck stock, or less.
Now you buy a stock for $100, and it pays you 4 dollars. Which looks bad, since that’s a 25/1 P/E figure. But, you’ve got virtually no inflation these days. So you’re actually getting the same kind of return for your investment in stocks, and that high P/E figure makes some sense, even if normally it suggests a middling high level of risk.
Of course if I were really clever, I’d wave my hands and speculate that a willingness to buy such “poor performing” stocks suggests that investors are expecting a fairly long run of ultra-low inflation. I have no clue as to what most investors consider a “fairly long run”, but it seems plausible right now that the Feds might be keeping inflation at a low low rate for another 6 months or a year.