David Fuller's view -
It is posted in the Subscriber’s Area but here is the opening, which quotes Warren Buffett extensively:
“It is no longer a secret that stocks, like bonds, do poorly in an inflationary environment.”
- Warren Buffett, ‘How inflation swindles the equity investor’, May 1977.
On December 31st, 1964, the Dow Jones Industrial Average stood at 874. On December 31st, 1981, it stood at 875. In Buffett’s words,
“I’m known as a long term investor and a patient guy, but that is not my idea of a big move.”
To see in stark black and white how the US stock market could spend 17 years going nowhere – even when the GDP of the US rose by 370% and Fortune 500 company sales went up by a factor of six times during the same period – the price chart for the Dow is shown below. [Ed: subscriber’s can see this in Tim Price’s letter and also recreate it in the Chart Library, should they ever wish to.]
So the US stock market suffered a Japan-style lost decade, and then some. Back to Buffett, again.
“To understand why that happened, we need first to look at one of the two important variables that affect investment results: interest rates. These act on financial valuations the way gravity acts on matter: The higher the rate, the greater the downward pull. That's because the rates of return that investors need from any kind of investment are directly tied to the risk-free rate that they can earn from government securities. So if the government rate rises, the prices of all other investments must adjust downward, to a level that brings their expected rates of return into line..
“In the 1964-81 period, there was a tremendous increase in the rates on long-term government bonds, which moved from just over 4% at year-end 1964 to more than 15% by late 1981. That rise in rates had a huge depressing effect on the value of all investments, but the one we noticed, of course, was the price of equities. So there--in that tripling of the gravitational pull of interest rates- -lies the major explanation of why tremendous growth in the economy was accompanied by a stock market going nowhere.”
That seventeen year period from end December 1964 to end December 1981, marked the valuation contraction cycle which occurred between two secular bull markets. The first of these lengthy bull trends commenced with the end of the US Depression and also WW2.
By coincidence, it was in the mid-1960s that I decided to change careers and head for Wall Street. Why? Because although I heard about the difficulties of the Depression from my parents, all I subsequently heard about the stock market during my adolescent years and early 20s was that it mostly went up, thanks to a booming economy.
The mid-1960s through 1981 provided a steep learning curve, as veteran subscribers will have heard me say on occasion during my financial career to date. Thereafter, the next secular bull market commenced from valuation contraction lows in 1Q 1982, before ending with the 20th century.
So what do we make of the S&P 500 Index’s historic chart pattern which dates back to the 1960s, not least in the context of Tim Price’s further assessment?
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