Dow 36000 Revisited

James Glassman is the polar opposite. Almost every piece of writing he submits is geared to preserving the buy and hold mantra no matter what real life shows to be true. The positions he takes are very instructive. Learning trend following and the psychology needed to win as a Trend Follower are helped by analyzing and understanding the faulty logic of Mr. Glassman. He provides great reinforcement of how to do things wrong which in turn helps to learn the right way.

He is back today with another article in the Wall Street Journal. We provide excerpts of that article below. TurtleTrader comments are in red.

JAMES K. GLASSMAN and KEVIN A. HASSETT

When our book, Dow 36,000, was published in September 1999, the Dow Jones Industrial Average stood at 10318. The Dow closed yesterday at 8736. What went wrong? Actually, nothing. Despite its flamboyant title, Dow 36,000 was a book of sober explanation, not of wild prognostication. We calculated that 36000 was the point at which the 30 stocks that comprise the Dow Industrials would be fully valued, and we warned that it is impossible to predict how long it will take.

TurtleTrader® comment: If you put a price target out there with no time frame to reach it, how can you have credibility? Predictions are pointless, but if you make a price prediction and attach no time frame to it and then expect to be taken serious -- it's just not logical.

But picking target prices was not what our book was about -- nor is it what investing is about. The book had three themes -- and they apply even more forcefully today than they did three years ago.

First, investors who can put away money for the long term (at least five years and, better, 10 or more) should invest mainly in stocks and stock mutual funds rather than in bonds.

Second, while stocks are risky in the short term, investors should buy and hold, and not try to time the market.

TurtleTrader® comment: No.

Stocks will not go straight up, we warned. But bear markets are unpredictable, and trying to guess the ups and downs of stocks is a fool's errand.

TurtleTrader® comment: Both bear and bull markets are unpredictable.

Third, stocks are undervalued relative to their long-run trend. We don't guarantee that the price of Tootsie Roll or Johnson & Johnson -- two of the 15 stocks we highlighted in the book -- will not decline over the next month or year. But based on our analysis of return and risk, a diversified portfolio of shares in good businesses is an excellent long-term investment.

The theory that shaped our book comes from some powerful data. Ibbotson Associates, the Chicago research firm, found that from 1926 to 2001, the average annual return, after inflation, of the large-cap stocks of the Standard & Poor's 500 was 7.6%, compared with just 2.2% for Treasury bonds.

TurtleTrader® comment: 7.6% is an average. Doesn't this Glassman strategy force you to live forever since you can't predict what periods buy and hold will not work? View the Japanese Nikkei 225 stock index chart. It reached nearly 40,000 in the early 1990s. Now it hovers around 10,000 12 years later. Do you think the Japanese still actually believe in buy and hold?

In other words, stocks return more than three times as much as bonds. Thanks to compounding, after 30 years, an investment of $10,000 in stocks will rise, on average, to more than $90,000, while a similar investment in bonds will rise to less than $20,000.

Higher returns are normally correlated with higher risk, but work by Jeremy Siegel of the Wharton School and others has found that if stocks are held over long periods, risk declines dramatically. Mr. Siegel looked at nearly 200 years, and found that during their worst 20-year period ever, stocks rose more than 20%. But for bonds, the worst 20 years produced a loss of 60%. Mr. Siegel concluded that the safest long-term investment for the preservation of purchasing power has clearly been stocks, not bonds.

TurtleTrader® comment: Siegel has publicly stated Glassman incorrectly used his theories to achieve the Dow 36000 thesis.

How can bonds be risky? Nearly all bonds are exposed to inflation, which erodes principal. In an inflationary time, businesses can respond by raising prices, so stocks tend to suffer less than bonds. Stocks also increase their earnings fairly consistently from year to year, while bonds pay a fixed rate of interest, which is practically guaranteed to decline in purchasing power with inflation. Sure, there will be recessions and accompanying bad profit news from time to time. But in the end, the growing economy will pull firms' profits, and share prices, back upward.

TurtleTrader® comment: No one is debating that stocks are better than bonds, we are debating the strategy (or lack thereof) Glassman proposes for stock trading.

But has something changed since our book came out? Certainly, Dow 36,000 has been put to a severe test. The U.S. has been through a lot in three years: the impeachment of a president, a disputed election for the first time in a century, the first attack on the U.S. mainland since the War of 1812, the first recession in 10 years, corporate scandals and a zealous political response that could create unintended consequences. What's remarkable is that, in spite of this, price/earnings ratios have remained higher than historic averages -- exactly what we expected.

TurtleTrader® comment: Hold on. You throw the 36000 price projection out there, but a few unforeseen fundamental events happen and your thesis goes out the window? Trend Followers could care less that war might break out or a recession might appear or that corporate scandals might blossom. The basic underpinnings of trend following take into account all of these unforeseen factors by following the market and not predicting it. Glassman uses these fundamental events as an excuse for why Dow 36000 did not happen.

No, the Dow is not at 36000 right now, and we didn't say it would be. But there is little doubt that, as long as the U.S. economy remains sound, stock prices will rise to 36000 and beyond.

TurtleTrader® comment: The Dow can get to 36000, but if you are going to be in the prediction business you better offer a time frame if you want your credibility. Trend Followers would love to see the Dow go to 36000 as well, but at least they don't try to predict something that can't be predicted!