What everyone forgets by concentrating solely on corporate earnings is the extraordinary cyclicality of price-earnings ratios. During 1973 – ‘74, median valuation dropped from 46 to 17 times earnings. This was a 63% haircut for a representative group of growth stocks with very few foul-ups. Polaroid ended up at 12 times earnings and nobody cared. Same for Coca-Cola and Walt Disney.
Price-Earnings Ratios of 20 Growth Stocks
September 1973 – September 1974
Price-Earnings Ratio Price-Earnings Ratio
Company September 1, 1973 September 1, 1974
Polaroid 78 12
National Semiconductor 71 5
McDonald's 62 14
Schlumberger 53 28
Automatic Data 52 14
Johnson & Johnson 51 27
Hewlett Packard 51 21
Walt Disney 50 12
Black & Decker 49 20
Simplicity Patterns 48 6
AMP 48 16
Digital Equipment 46 16
Burroughs 44 19
Schering Plough 44 2
Perkin-Elmer 43 17
Coca-Cola 42 12
Texas Instruments 42 14
Upjohn 42 17
Xerox 41 15
The average stock on the Big Board in 1974 sold then closer to $25 a share. Not what we have today with Apple and its ilk. Only a handful of stocks sold above $100. Hundreds of names wound down into single digits. Meanwhile, in Greenwich, Connecticut, home to white-shoe money managers, a handful of restaurants wouldn’t seat you without a jacket and tie. Wall Street, then a strait-laced disaster, became a hypersensitive, volatile playground left to professional speculators and short sellers of uncertain heritage, so they said.
Currently, JPMorgan Chase’s forecast on interest rates for 2022 seems self-serving, by stroking their clientele into acceptance of their 40% allocation to fixed income investments. Nobody’s forecasting rates above 2.55% among sister banks. Several stay closer to 2%. Ten-year Treasuries are thought to range from 1.75% to 2.25%. The 2-year rate is expected to slither between 1% and 1.5%. It just hit 1.6%.
Quoting benign numbers abets whistling in the dark. I’m at least 100 basis points higher all along the maturity spectrum, even if the Fed’s tightening proves comparatively benign. Simply, I don’t expect inflation to remain quiescent for wages, raw materials and finished goods like automobiles, even lumber and housing. Demand pull is a powerful dynamic. What we’ve got today. Let’s hope I’m wrong but the history of interest rates bails me out with its wild antics.
My recital: First, note that interest rates proved incredibly volatile during postwar decades. Forecasters nearly always missed the boat. Secondly, the country encountered aggressive Federal Reserve Board chairmen from decade to decade whose sole interest was to stamp-out inflation, not shield investors from the pain of a sorrowful market. Today’s chairman, who’s name escapes me, keeps an eye on the stock market. He’s a gradualist who has shored up the market with over a trillion dollars in FRB buying Treasury notes.
This put the lid on interest rates along the entire yield curve, from money market rates near zero, 10-year Treasuries at 1.5% and 30-year paper as yet under 2%. Anyone who hasn’t arbitraged the yield curve, buying 5-year BB debentures yielding 4.5% against the current cost of borrowing, 75 basis points, has left bread on the table. Past year, the high-yield sector returned 5.3% vs. minus 1.3% for Treasuries.
So far, everyone ignores what happened in 1982 when Paul Volcker put interest rates up to 15%. Stocks sold down to book value and yielded 5%. Currently, the S&P 500 sells at twice book, yields around 1.5% and goes for over 20 times next year’s earnings projection which assumes a pick-up in GDP growth to at least 2.5%.
Same goes for the financial meltdown of 2008 - ‘09 when markets sold for a song. Few money managers operating today were operative on Black Monday, 1987, when the averages dropped 22% overnight - for no good reason. While I was doing a hostile takeover in 1987, I paid 8% for a traunch of preferred stock. Keeping a bank line of credit open for a billion cost me a 1% fee.
Back in the sixties, when McChesney Martin took away the punchbowl raising margin to 90%, I relied on money brokers which cost me at least 8% interest. It’s hard not to conceive that interest rates aren’t abnormally low and headed much higher unless recession is around the corner. Nobody’s call right now.
The scary word trotted out periodically by economists and market operators is “Stagflation.” This condition happens when the country fails to grow but is beset by serious inflation. We sustained such a horror in the seventies when union wages escalated, annually, by 8%, thanks to Jimmy Hoffa and Detroit. Car makers offset all this with 7% price hikes for new cars. This made them uncompetitive, worldwide.
When I reached for my trusty charts on the economy, interest rates and inflation going back to the sixties and seventies, I was dutifully shocked, horrified by the starkness of the numbers. Viscerally, I remember how hard it was to make serious money then. Polaroid and Xerox had topped out. I wasn’t interested in cigar smokers proliferating. Gillette’s safety razor left me cold as did Vendo’s vending machines. The Street was late in its understanding of the leverage in tech. Then, Texas Instruments and Motorola took off.
Anyone investing in high-grade bonds has lots of explaining to do. U.S. high-yield bonds returned 5.3% for the year while Bloomberg’s investment grade bond index was 1.2% negative. Such hide-bound investing reminds me of late fifties when stocks were still considered too speculative. It took decades for the 1929 crash to recede from consciousness.
United States Steel, General Motors and Royal Dutch Petroleum were what my parent’s “Customer man” recommended to them. Such managements donned starch white shirts, but later on nearly buried their companies in hapless capital spending at the top of economic cycles.
For now, the Street has it all wrong and needs to catch up with reality.