Wednesday, September 07, 2005

Boom 1983-99 0 comments

(P.S: Sorry for any disturbances the advertisements above may have caused you)
I just realised that I had been writing about bear markets and collapses in my last four entries in this blog, so this next one has to be a bull post to balance out. And what a bull it is too: the longest bull market in recent history, yielding an average annual total real return (with dividends reinvested, adjusted for inflation)of 15.7% from the period 1983 to 1999. (Where else do you think Warren Buffett got his well-quoted figure of 15% return from the market that an investor should expect from?)

A secular bear market invariably pushes valuations down in alignment with the most pessimistic outlooks, and this was the case with the bear in the 1970s. Although the Dow breached 1000 points in 1982, it was trading at a market multiple of 7 times, an amazingly low figure when you compare it with market multiples we are used to today of ~15-20 times for developed markets. The tide began to turn; bargain hunting had been proceeding the last few years but now a new powerful force took over: corporate takeovers. From 1984 to 1987, mergers, takeover, buybacks and leveraged buyouts slashed the supply of stock available on the market. This was the age of the junk bonds and the chief protagonist was Michael Milken of Drexel Burham Lambert (would probably cover in detail in another post). Corporate America was recognising the cheap market prices that they could acquire other companies (mergers) or even their companies (management/leveraged buyouts) for, and were scrambling to take advantage. The movie "Wall Street" probably epitomises the mood of excitement and greed enveloping the market at the peak of this period.

Black Monday in 1987 put an end to the market momentum and by 1990 the LBOs and mergers had died out. However, it turned out that the second leg of the bull market was just breaking stride. The participation of the individual retail investor in the stock market was the key factor in this phase. In the US the rise of the 401(k), similar to Singapore's CPF, meant individuals had to be responsible for managing their retirement funds which had been regularly contributed by employers while they were working. And they chose the stock market to put their money in, which would generate liquidity, that lifeblood of markets, for the next decade.

There are several reasons why stocks were the preferred choice. The old generation which had experienced the 1970s bear market had been replaced by a new generation of investors who saw the surge in the DJIA from 1000 points in the early 1980s to 3000 by 1991; clearly the desire to participate in this boom grew with the index. The collapse of the Soviet Union saw the end of the Cold War; there was a rush of new optimism now that the world could concentrate on economics instead of politics or security. Commodities prices posed few problems (ie. low inflation) for the economy as few bottlenecks (political or otherwise) proved particularly bad and supply could be easily ramped to meet rising demand.

By the mid 1990s the media had joined the circus. Financial talkshows and news bulletins became a staple on the TV diet of many Americans now hooked on the market. Presenters became celebrities, such as Louis Rukeyser whose show often generated stock ideas for the following day. Mutual funds (known as unit trusts in Singapore) became the investment vehicle of choice for many small investors, due to their incessant marketing and the superb performance of certain fund managers (such as Peter Lynch) which was trumpeted and benefited the image of the entire industry tremendously. Due to pressure on them to outperform the market, many fund managers practised momentum investing, chasing up the valuations of popular stocks because they offered the most liquidity and high probability of outperformance. And they did, because the flow of liquidity ensured that the house of cards would not collapse. The 100 most favoured institutional stocks were sold at price earnings ratios 25-50% above their historical averages; stocks like Time Warner (85 times PE), Coca-Cola (39 times), Gillette (36 times), Pfizer (31 times), Oracle (32 times); this was reminiscent of the Nifty Fifty of the early 1970s.

As long as the music played the game carried on. The surge in profile of technology stocks, in particular Internet stocks, in the mid to late-1990s brought the market optimism to a climax by the turn of the millenium. Even astute observers like Alan Greenspan, the Fed chairman, expressed optimism about a New Economy fuelling an unprecedented rise in productivity that was the underlying force for the market rise; it turned out that he had got the chicken and egg problem in reverse; it was the investments put into implementing new IT systems that had boosted earnings, not any productivity gains as a result of implementing these IT systems. This became painfully clear as the market reached a crescendo in 2000 and then finally the house of cards collapsed, conclusively bringing an end to nearly two decades of generally uninterrupted boom, a boom that had brought stock valuations from dirt-cheap to downright unbuyable.

(1) Bull! A History of the Boom 1982-1999 (by Maggie Mahar)




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