John wrote:If you fit the last century's earnings into an exponential growth curve, and extrapolate that curve to 2009, then you get a trend value for about $41 for 2009. So in the absence of a bubble, you should not expect earnings per share to be above $41 for some time to come.
But it's a lot worse than that, since earnings have to fall much farther, to compensate for the bubble highs. This is the Law of Mean Reversion, which says that if a value is well above trend for many years, then it has to fall well below the trend value for roughly the same number of years. This is simple math, since it says that the average growth rate in the future will equal the average growth rate in the past.
During bubbles, there are always people who say "This time it's different." We saw this in the housing bubble, where I heard financial analysts, economists and journalists say, "Housing prices can't go down -- people have to live somewhere," and "Banks won't foreclose -- it's not in their interest to do so" and "These housing construction firms know what they're doing, and they wouldn't be building houses if it were just a bubble."
All of these arguments proved to be completely wrong, but financial analysts, economists and journalists are apparently too dumb to learn from their mistakes.
John,
The more I learn and the more I see the more I think you are right, at least in your underlying arguments. In times like these everyone will be wrong about things in the short term as "the economy" jerks us around in order to get where it needs to be but it is crystal clear to me that Generational Dynamics and our past (which is where trend reversion comes in) chart the course for the future. I believe that with a clear, unbiased view of our past misdeeds and an understanding of Generational Dynamics one can see fairly clearly where we will end up. Given how long it has taken to get where we are and our reaction to the problems we face I believe that we face a long downhill road, much like the Japanese travelled these past 20 years. But I also see the possiblilty for a complete unraveling of the world economy as all of the seemingly manageable problems coelesce into a giant spiral downward.
The big challenge for me is to practice patience and to realize that history and trend reversion will win out in the end and that they will use all the powers at their disposal - greed, fear & time - to do what they must. John Hussman is perhaps as wise as any financial advisor but he is still too close to the problem and the problem is that investors believe that since something happened in their past it must continue. In fact, it's the fact that we had bull markets in stocks and housing for 2-3 decades (or is it 5-6 decades?) that ensures that we will NOT have bull markets in stocks and housing for a very long time.
One thing I heard in 2008 as the bulls were getting pummeled and I was feeling superior was that a secular bear market eventually hurts everyone. I heard that but didn't really understand it until 2009 and the 60% retrace. I now know that I'm lucky to be just a bit worse off than 2 years ago and that my priority needs to be to protect what I have, not to outsmart the market. Luckily I started paying off a very considerable amount of debt brought about by an expansion of my business in 2006 and am now almost debt free. I am now doing everything within my power to make sure I can survive whatever the world throws at me over the next decade or two. My goal is not to beat the markets but to take care or me and mine without becoming a ward of the state.
--Fred
http://www.acclaiminvesting.com/