The Breakfast Table

Fun and Games


Let’s turn to a more pleasant subject. Yesterday, Mark McGwire hit his 63rd homer. But it’s peculiar. When he hit his 62nd he got banner headlines on the first page of the Post and Times. His 63rd gets only a footnote on the first page. Why is that? You would think that hitting 63 is a bigger feat than hitting 62. You might say that 62 was big news because it broke a record–Maris’ record. But 63 also broke a record, McGwire’s.

While I’m on the subject of games, let me say something about the stock market. Whether or not that’s a pleasant subject depends on who you are. B can now buy for $8,000 what A paid $9,000 for two months ago. That’s good news for B, and bad news for A.

There is an interesting article about all this in the Wall Street Journal. It’s by Jerome Siegel, a professor at the Wharton School. A year or so ago he was one of the leaders in explaining, and possibly also causing, the height of the stock market. His explanation was that throughout most of our history investors had consistently overestimated the riskiness of holding stocks and therefore would only pay a low price for them. The price was so low that the actual rate of return on that turned out to be much higher than the rate of return on an asset that they did not consider risky, such as a Treasury bond.

But then in the late 1990s investors learned, partly thanks to Professor Siegel’s work, that they had been paying too little for stocks all along. On the average they had been willing to pay for stocks only 14 times their earnings. Learning of their past errors they became willing to pay 25 times a stock’s earnings. Even now, after the decline, they are paying 20 times earnings.

All of that is plausible (meaning, possibly true). But I think that a little looseness in the use of tenses in Professor Siegel’s article may give an incorrect impression.

He says,

“As investors become rightly convinced of the past superiority of stocks as long-term investments, they will bid stock prices even higher, a process that generates higher short-run returns and reinforces their positive outlook. But at these higher prices, stocks will offer investors lower future returns, just as buying a stock after the good news is out will not be profitable to new investors.”

I think it would have been more prudent to say,

“As investors became rightly convinced of the past superiority of stocks as long-term investment, they bid stock prices higher, a process that generated higher short-run returns and reinforced their positive outlook. But at these higher prices, stocks offered investors lower future returns.”

That would not have left the impression that the best is yet to come. It would leave open the possibility that we had over-learned Professor Siegel’s lesson in July when the market was at its peak, and may still be over-learning it. Perhaps investors were indulging in irrational exuberance, to coin a phrase, in July. Perhaps the market is at a rational level right now. But if we now go through a phase of irrational lack of exuberance, it may be a long time before investors see the returns they expect.

I really have no quarrel with Professor Siegel’s article, except for the use of tenses in the paragraph I have quoted. I am, however, made uneasy by the headline the Journal gave to the article–“Why Stocks are the Investment of Choice”–if that is understood to mean that they are the investment of choice on the morning of September 16, 1998.

I am implying no forecast of the market. My answer on that subject, as on so many others, is “Who knows?”.