by John Mauldin
(John Wiley & Sons, New York, 426 pages) $24.95
Batten down the hatches. Circle the wagons. Prepare for the next set of market
disasters. That's the view of a veteran investment counselor who says that the worst wasn't over with the end of 2002. A secular down market merely took a breather last year. It is now primed to start all over again for several years.
The bears, who wreaked havoc on Nasdaq in the 2000-2002 period, are about to come back. And, unless one is ready to adopt defensive strategies now, it is going to get very ugly over the next five or six years. After that, the stock market will once again make sense. So writes John Mauldin, the president of Millennium Wave Investments in Dallas, Texas.
One doesn't have to agree with the author in all of his destructive and Cassandra detail to find this book compelling. Mauldin's case for a secular bear market is based on history. He constantly cites the historically pricey p/e numbers. Many price earnings ratios remain in the 20s. That's still far too high, he insists. Bull markets usually start with a single digit p/e or maybe one in the low double-digits. For example, in 1983, at the outset of a bull market, the typical p/e was 8.3.
The author also contends – with no apologies to the market "cheerleaders" and their constant refrain of buy and hold – that no bull market in his history has ever begun with p/es at such lofty numbers. The major indexes, despite three years of bloodletting followed by a market recovery last year, still remain far overpriced, he contends.
That means more pain is coming, he predicts, especially for the tech companies. Traders might be disturbed to read that Mauldin believes that the Nasdaq is, by far, the most overpriced of the major markets. It will likely experience many more de-listings over the next bearish five or six years, he predicts.
"The Nasdaq is more vulnerable than any other index," (page 110) Mauldin warns. It doesn't weather storms very well. For example, he notes, at the end of 1996, the Nasdaq listed 5,556 companies. Today, that number is down to about 3,600. And since the Nasdaq has a survivorship bias, Nasdaq's performance has actually been worse than the published numbers.
But then Mauldin cites a number that is horrid no matter how one views it: Some $4 trillion of Nasdaq equity had been recently lost since March 2000. Then comes this augury about the Nasdaq in the coming bear market.
"I think the day could come when the Nasdaq index is lower than the S&P 500," he writes (page 100). Nasdaq stocks, he argues, could drop another 50 percent from current levels.
And more than traders will be hurt by this overpriced market. A generation of retail and institutional investors – buoyed by the outsized returns of equities in the 1980s and 1990s – are potential targets in a coming market slaughter. They will be paralyzed, Mauldin believes, because they are preparing to fight the last war.
Dip and Crash
Investors, Mauldin says, have been oversold on a buy-and-hold philosophy. That's because it recently worked for them. After every dip and crash in the 1980s and 1990s, they hung on and bought more large cap stocks or index funds. They were sold on the "Stocks for the Long Run" thesis. That's even if they never heard of the author and the book.
Mauldin, in this book, frequently hammers Professor Jeremy Siegel, practically depicting him as the Irving Fisher – a famous academic of the 1920s who insisted that stocks would jump back after the crash of 1929 – of our time. Mauldin's point is that Siegel's model no longer applies. In fact, it is now dangerous.
"The recent era of profitable buy-and-hold stock market investing, using index funds and chasing high-growth large-cap stocks has ended, and will not come our way again for several years. Until then, we need to change our investment habits to adjust with the times," the author writes. (page 8).
But there is another part of his market pessimism case that is convincing – inflation will put pressure on stocks, driving them down. The inflation will be caused by – what else?-governments spending too much money, running huge deficits and printing money. This, to me, may be even a more effective argument than his price earnings numbers even though the author doesn't raise it.
The United States government is now bogged down in a war in Iraq. The government, as always, is going on a spending binge. It is running huge annual deficits of $500 billion and shows about as much will to curb welfare spending as it does to curb defense spending.
In our lifetimes, when was the worst period for the stock market? Most often cited is a 17-year period between 1965-1982. That's when the stock market was basically unchanged. What was happening during most of that time? The Vietnam War.
War, and the inflation – which is a term that means hidden taxation – that came with it depressed stocks. In this environment, hard assets, including gold and real estate, were the best places for money. It was also a time in which many equity heavy portfolios were wrecked. Towards the end of this troubled period, it also led the horoscope readers of "Business Week" Magazine to predict the death of equities by the end of the 1970s (That's fine. The witch doctors at Business Week, in late 2002, also predicted that stocks would be up in the single digits in 2003).
Yes, it's tough to predict markets, but Maudlin makes an effective case for trouble ahead. And he doesn't add to his brief what may be the strongest part of his indictment: The United States now appears in the midst of a worldwide crusade to bring democracy to the most troubled parts of the world, a big spending Wilsonian policy that could impoverish us all. What if the occupations of Iraq and Afghanistan go on for years and years? What if George Bush and company are the latest incarnation of "the Best and Brightest," leading this country into a political, economic and social quagmire that divides our nation the way Vietnam did or Algeria did in France in the early 1960s? What happens to stocks then?
No question about it: Stocks head south fast. What are the consequences if the author is right about the coming bear?
Mauldin says the most vulnerable to a bear market scenario are those individuals and institutions projecting nine percent annual equity returns over the next five years. Here we are speaking of individuals who think a rosy retirement is right around the corner because stocks will inevitably rise in the next few years.
"If you expect to retire in 10 years," the author writes, "you should not assume a 5 to 6 percent return on the average stock or index fund from where we are today." (page 72).
Pension Funds
We're also speaking of under-funded corporate pension funds. Many of their trustees are in never-never land. They think that fat market returns duplicating the halcyon 1990s will save them.
For these deer in the headlights, Maudlin's advice is explicit: Buy stocks very carefully. Look for value. Better than that, think about alternative investments, especially hedge funds. Have some real estate and buy some gold. That's because, given the nation's trade and fiscal deficits, it is inevitable that the dollar is headed down.
One might quibble with certain parts of Maudlin's points, which are forcefully argued and well researched. But given the huge deficits, the disturbing softness of markets and Washington's bi-partisan reckless spending policies, it is impossible to ignore Maudlin.
