Markets
DOW 36,000 -- Unrepentant
Five years after their best-selling book, James Glassman and Kevin Hassett sill believe in the case they made -- stocks are cheap and will continue to make money.
By James K. Glassman, Contributing Editor
From Kiplinger's Personal Finance magazine, December 2004
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Even in the short and medium term, bonds have proved risky. Long-term Treasuries suffered losses in three of the past ten years, as did stocks. Research by Ibbotson Associates has found that for ten-year periods between 1926 and 2003, a portfolio composed of 90% stocks and 10% long-term Treasury bonds has never lost money, but a 100% bond portfolio has.
Siegel's work highlighted what economists call the "equity premium puzzle." Stocks return more than bonds (that is, a premium), but stocks are no more risky over the long term. What's the explanation?
Academics have fretted over this question for years. In Dow 36,000, we offered a possible answer: Investors were irrationally fearful of stocks. They saw the wild volatility of stocks in the short term and extrapolated that risk to the long term. It was like saying that because it rained for three days straight, it would rain the whole year. In fact, stock investing gets less and less risky the longer you hold on. Investors' irrational fears kept prices low.
Shaking off fear
But in the early 1980s, something changed. Investors began to wake up to the true risk of stocks and began bidding up prices. Kevin and I said that this process was "perfectly rational" and was likely to continue. We warned that "a cyclical downturn, after nearly two decades of growth, could shock investors who have become used to good times" and that "political unrest around the world could boost the risk premium," especially because "aggressive, unpredictable nations like Iraq and Iran now have greater access to weapons of mass destruction." But we believed such setbacks would be temporary.
Why did investors become less risk averse starting in the 1980s? First, education. They learned the truth about stocks from the work of economists, such as Siegel, from responsible financial journalists and from mutual fund companies, which did a good job of educating their clients. Second, new investment options were created. Investors were encouraged by the advent of tax-deferred retirement accounts -- IRAs and 401(k) plans -- to keep their money at work for the long term. Suddenly, the idea of jumping in and out of the market became unattractive.
Because investors were not demanding such high returns from stocks, prices (and price-earnings ratios) rose. Americans no longer required a gigantic equity risk premium to get into the market. Using an established financial formula, we calculated that if the risk premium fell to its proper level -- about the same as bonds -- the stock market, as represented by the Dow, would go to about 36,000.
Although Dow 36,000 was often criticized for pumping up the tech bubble, the stocks we highlighted in our book were mainly boring, value-oriented securities. Our reasoning was that if the entire market was cheap for long-term investors, why speculate in a go-go firm without earnings?
The keepers
In the book, we cited 15 specific stocks as good investments. Our preference was for businesses that had strong, defensible market niches and a history of generating a lot of cash. Kevin and I have monitored an imaginary, equally weighted portfolio of these 15 stocks over the past five years. From October 1999, when Dow 36,000 was published, through mid October 2004, the portfolio rose a total of 17%, compared with a loss of 7% for the S&P.
Our list includes such superb companies as Gillette, Johnson & Johnson, Tootsie Roll Industries, Wells Fargo and Cintas, which rents and sells work uniforms. There were only two tech companies, Cisco Systems and Microsoft; their prices have declined over the past five years, of course, but I still like them. In fact, there is not a single stock among the 15 that I would drop from the portfolio.