November, 1995

Dear ICE Subscriber:

The ICE is devoted to publishing materials on the relationship between the Bible and economics. Normally, I do not comment on the economy. This month, however, I want to mention some of my concerns.

One of ICE's fundamental assertions is that there is a cause-and-effect relationship between ethics and prosperity. If God does not bring predictable sanctions in history in terms of His covenant law, then a uniquely Christian social theory becomes impossible. Christian social theory would then be little more than baptized humanism — which it has been since about 1700.

The prophets came before Judah in the 8th century, B.C., warning of negative sanctions to come. The Babylonian captivity began in the early sixth century. That's a long time to wait for a demonstration of God's covenant sanctions. But what about us?

The U.S. Supreme Court legalized abortion in January, 1973. Within months, a major stock market fall began. In 1974, median family income stalled, and it stayed flat for over a decade. It is still close to flat. Economists offer all sorts of explanations for the end of personal economic growth, but basically there is no clear-cut explanation. Frank Levy's aptly titled book, Dollars and Dreams (1987), states the dilemma well. From 1945 through 1973, the average weekly earnings of all 40-year-old men, adjusted for inflation, rose by 2.5% to 3% a year: a 27-year boom. Then, overnight, it ended.

In the eight years following Richard Nixon's first term (1973–80), the average family's real income declined by 7 percent. During Ronald Reagan's first four years in office it grew by only five percent. What went wrong? Like people in the middle of the Great Depression, we are not quite sure.

In 1987, the year Levy's book appeared, the stock market experienced a fall from 2,700 to 1700: 508 points in one day. Beginning in 1991, corporate America has fired 500,000 employees each year.

Yet the stock market has gone up. It bottomed in August of 1982 at 777. It has gone up higher than anyone could have dreamed then. Here is the anomaly: as the stock market has gone up, personal income from our labor has stagnated. Investors seem to be getting rich, but workers are going nowhere. Middle-level managers in their 50's are being fired. The dream of lifetime employment is over.

In my view, this discrepancy cannot go on much longer. The labor market is telling us stagnation. The stock market is telling us growth. Academic economists — always the last to get on board a trend — are now saying that the stock market has risen by 10% per annum and will continue to do so. Keep fully invested in stocks, they tell us. This has made me very nervous. On October 9, I got pushed over the edge. On that day, the Wall Street Journal ran ad for one of its own products, a piece of retirement planning software. Here was the headline:

How To Retire As A Millionaire
You can do it — if you start early and "plan ahead."

The software program is called Plan Ahead. No doubt it is a fine program. All you have to do is punch in the numbers — your monthly savings plan — select the rate of return you expect, compounded, and see your retirement dreams come true on screen. Easy street!

Let's do a little figuring. I'll use my $35 Texas Instruments BAII Plus financial calculator. Let's assume that instead of paying their investors any dividends, the companies begin reinvesting all of their earnings in order to increase growth. (Why not quit paying? Companies pay practically nothing out in dividends anyway. The investor today is getting only 2.4 cents in actual dividends for every dollar's worth of stock that he owns — the lowest figure ever recorded, even lower than in October, 1929, just before the Great Crash.)

If the Dow Jones Industrial Average is at (say) 4,700, and you buy a Dow Jones stock index mutual fund in the hope of gaining a 10% per year after-tax return on your investment for 30 years, the Dow would have to go to 93,236 to achieve your goal. To keep this dream alive, it would have to go to 186,000 in 37 years, and 372,000 in 45 years, and so on, year after year, forever.

You don't need a $35 calculator to prove this. You can do it on a piece of paper. At 10% compounded, any number doubles in just 7.2 years. So, a 4,700 Dow becomes 9,400 in 7.2 years, 18,800 in 14.4 years, 37,600 in 21.6 years, and 75,200 in 28.8 years. To which I say: "It ain't gonna happen, Charlie."

Would you invest your money with anyone who is predicting a 93,000 Dow? Sure you would. You probably already have. Or if you haven't, your pension fund manager has done it for you. The 1995 promise, "10% per annum compounded, long term," is a sophisticated way of saying "Dow 93,000 in 2025." The so-called expert is predicting the economic equivalent of a 93,000 Dow in 2025 if he is telling you that the U.S. stock market on average has returned 10% per year to investors and will therefore continue to do so.

Millions of Americans are taking this hype — it's too ridiculous to be called hope — so seriously that they have been investing $10 billion a month into stock mutual funds. If this isn't mania-driven speculation, then what is?

The End of the Illusion

The stock market investment advisors I respect most are skittish. They think this market is in the mania stage. Neither fundamental analysis nor technical analysis reveals good reasons for staying invested in this market, let alone fully invested.

Personally, I am completely out of any stock mutual fund. I am really worried about the possibility of a mutual fund meltdown. It will probably come in stages. In 1969, at the end of the go-go years of mutual fund investing, in the midst of a stock market collapse, more money flowed into mutual funds than ever before. Investors were told to "average down," which was supposed to mean buying in at lower prices for the long haul. What it turned out to mean was throwing good money after bad. In 1970, they learned.

The Dow Jones Industrial Average peaked on February 6, 1966, at just under 1,000. It exceeded 1,000 inter-day, but fell back. The next day it started down. The Dow fell 25% in 1966. But then Johnson's wartime inflation made the economy boom. The market recovered. But, adjusted for inflation, it did not reach the purchasing power of the 1966 1,000 until much later. How much later? This year. It took 29 years.

If the Dow had returned 10% a year, and if there had been no inflation, it would be almost 20,000 today. It would be almost 80,000 in today's inflated dollars.

What I see is a stock market mania that will end terribly for millions of Americans. Their dreams of a safe, comfortable retirement will be smashed. They have now — at long last — abandoned hope in Social Security. This is wise. But Americans have been pouring all of their investment money — 100% — into stocks since 1991. Of all the money ever invested in stock mutual funds since 1924, 80% of it has come in since 1990. I fear that this is going to provide us with another example of Vilfredo Pareto's century-old 80-20 rule.

If you have a pension fund, and the fund allows you to select from stocks, bonds, and a money market, you should seriously consider putting half or more into the money market. You may miss out on the last move of a mania-driven market. The important thing is that you miss out on the first move of a panic sell-off. Here are a pair of selling indicators. If the 90-day T-bill rate moves above the 30-year T-bond rate, take this very seriously. Also, if there is any sagging in the amount of money coming into stock market mutual funds — below $5 billion for two consecutive months — consider it ominous.

What am I recommending? Liquidity and safety. We must choose among safety, liquidity, and yield. Today, I would sacrifice yield. I will accept low 5% interest rates — and even lower rates if a deflationary recession arrives — in order to preserve my capital. The old phrase is correct: at this point, my goal is not a return on your capital; it's a return of my capital. Richard Russell puts it this way: the winners will be those who lose the least.

I own some land. I have put it up for sale. I hope I can sell it before the stock market starts down. Because land is illiquid, you have to get it sold before the market starts down. You can't wait until everyone knows trouble is coming.

If I owned my own home in a high priced city, I would sell it. If I could get $350,000 for it in cash and rent a comparable house for, say, $1,500 a month, I would sell now. If I had a mortgage with less than 30% equity, I would surely sell. I would keep the cash and wait for real estate bargains. For those with cash, a recession creates tremendous buying opportunities. There is nothing like fear to induce negotiating.

Stock market dividends now yield well under 3% a year. In other words, for each dollar's worth of stock, the investor gets less than three cents a year on his money. That's where short-term interest rates were in early 1994. Now, however, short-term rates have almost doubled. The only reason to invest in U.S. stocks today is on the expectation that stock prices will rise enough to compensate for the low dividend rates compared to what a money market fund pays. It's the greater fool theory: musical chairs.

What about today's Price/Dividend yield of 2.4? Is this telling us something important? I think it does. I'm not alone in this opinion. Some of the most savvy stock market advisors in the business are very concerned about it, such as Richard Russell (Dow Theory Letters), Geraldine Weiss (Investment Quality Trends), and Bob Prechter (Elliott Wave Theorist). There is a reason for their concern: low P/D yields historically precede market collapses. Never before has a 2.4 ratio occurred. This is ominous.

One thing is sure: a P/D ratio of 3 or less has never been a prelude to a stock market boom. Maybe this figure doesn't scare you out of the market, but it sure ought to scare you from putting any more money in, including your automatic reinvested fund returns.

By the way, have you ever actually talked to your accountant about determining what the buying price was for each share of reinvested mutual fund earnings, so that you can assess what you will owe the IRS in capital gains taxes when you sell? It gets even more complicated if you sell out in stages. If you haven't thought about this problem, it's time to give your accountant a call.

I know what happens in recessions: donations to small parachurch ministries fall. Donors get scared. They start cutting expenses. It's inevitable. That's why ICE owes nothing to anyone. It is debt-free. I take no salary. I have recently sold a fine piece of property that ICE owns. The final transaction is scheduled to take place this month. Let's hope the stock market holds up until December 1. I put the property up for sale months ago, since land is not liquid. I think it's time to get liquid. I now recommend that you consider the security of a simple bank account to the lure of stock market riches. If you think we're in a market mania, sell. Don't get greedy. Don't bet your future on the final manic phase. If you try to get out at the top, you'll get locked in when it falls. If you can't see a sound economic reason why a market is booming, that's a good reason to get out.

Sincerely yours,