We've heard it going on two years now. The event that will help us emerge from this punishing bear market is always "just around the corner." First it was the "set in stone" rule that it takes nine months for a Federal rate cut to have any effect, which meant things would be righting themselves in, oh, October of 2001.
Then it was the tax cut, which put a few shekels in most Americans' pockets. I don't know about you, but my $600 check arrived on the same day as a notice from Fairfax County, Va., that my county taxes would be increasing by -- you guessed it -- $600. Great, thanks. I enjoyed that.
Regardless of my personal tax windfall, the rhetoric on both sides of the issue miss the fact that, in the grand scheme of things, this tax cut didn't make much of a difference. It didn't provide consumers with an enormous pump-priming amount, as some claim; nor is it in any way to blame for the current state of the economy. After the tax cut, continued consumer spending was touted as a key way to keep the American economy out of recession. Never mind the fact that consumers are deeper in debt than at any point in modern history -- if they keep spending, the economic engine will keep running. More on this in a minute.
And finally, there's the simple negativism argument. The seemingly endless corporate scandals, the sudden revelation of poor outside investor protection, the fallout and uncertainty from last year's terrorist attacks, and the subsequent war on terrorism have made the U.S. more conservative. Once these things are resolved, we can get on our merry way, the theory goes. Great theory, except it's based largely on stupidity. If anything, it isn't the current negativism that got us into trouble, but years and years of positivism -- of people spending themselves into debt.
Each time things are "supposed" to get better, it just hasn't happened. Let me spoil the ending for you: Eventually, things will improve. In the meantime, many investors are asking: What else is coming down the pike? Is there another shoe, and if so, when will it drop? How many more hits do we have to take before things get better?
The answer is plenty. Many things can still go wrong in the market. Once upon a time, the stock market was believed to be predictive of the economy -- it began to rise before things were apparently improving. But this is the first economic drop in an environment where the majority of private individuals are shareholders. This, I think, is a good thing. What's not good is that many people now treat the Dow Jones Industrial Average, or worse, the Nasdaq, as the primary indicator of economic health. Bad idea, one that has led to some awful regulatory decisions and points to plenty more in the future.
Regulators are generally political appointees. Why would they want to rip off the rose-colored glasses and highlight problems, when everyone points to the market to say, "Look how great we're doing"? It's as if people want to use the stock market as a barometer when times are great, but as the equivalent of an Ouija board when times are bad. And that leads to bad decisions by shareholders, corporations, and regulators. We can point to the long-term sucker-jobs pulled off by Enron, WorldCom, and others as proof, but we're far from done.
Where is the official indignation over corporate pensions inflated with return assumptions that have no bearing in reality? You own a company with 9%-plus expected returns for its pension? Time bomb. Get away from it. But until something actually goes wrong, not a damn soul in Washington will be interested in the issue. It's important because every penny of "overfunding" in pensions gets counted as income, even though the company doesn't really have access to it -- even though it doesn't really exist.
In the late 1990s, investors granted unprecedented multiples, including valuing the entire dot-com sector at a combined $1.3 trillion, while, as a whole, these companies destroyed billions in capital. Our collective valuation of telecommunications companies and their ability to burn through money, as it turns out, was worse. Companies wasted the money ($600 billion in debt, another $700 billion in equity raises) from 1996 to 2000, but we didn't adjust our expectations until 2001. Does that mean the "trouble" began in 2001? Absolutely not.
Then there's the mighty consumer, whose open pocketbooks have kept the economy afloat. According to a recent study, the amount of debt taken on in the 1990s by the middle fifth of all American households was more than double the size of the increase in their stock holdings. The average American family has, according to the Federal Reserve, more than $13,000 in revolving (mostly credit card) debt, the highest level in history. The amount of personal bankruptcies in the U.S. is at an all-time high, more than double what it was in 1990. Do we really think the consumer can keep up current levels of spending? And more importantly, is there anyone, given the increased risk more debt entails, who can argue this is a good thing?
That's another dropping shoe, and it will be a big one. And once again, it has nothing to do with the market -- bankruptcies were already spiraling in 2000, before the big drop. What happens when the increased borrowing needs by the U.S. government force interest rates upward? If the American consumer is truly indebted up to the gills, it'll be a catastrophe.
We haven't even talked about the long-term effects of a potential war. This could go in any direction. Wars are generally pretty good for the economy, but all bets are off if, for example, Iraq or its assignees detonate a chemical warhead in Tel Aviv. I frankly hate thinking of wars on economic terms, as it seems to belittle those charged to lay down their lives for our safety. Still, the threat of a war with Iraq is hardly an overall psychological boost for investors. That shoe that may or may not drop, but if it does, we have no idea what it will look like. That's the kind of uncertainty that drives the risk-averse bananas.
I'm buying anyway
There's a simple truth in investing: When you put money into something apparent to the rest of the world, you're hard-pressed to make money. The above scenarios are reasons to be interested in a stock market that has dropped so precipitously from its highs. Yes, it may drop more. Yes, the recession may be long-lived. But it will end, and well-positioned companies will once again benefit.
So what should one do about the real possibility of more pain in the markets? Well, for one thing, ignore the short-term prognosticators. They keep saying things will get better "any minute now." Things will get better -- when things are good and ready to get better, and that means there's more write-downs and business collapses to come. If the government steps in and tries to keep them from happening, it could take even longer.
But plenty of companies will emerge with a stronger competitive advantage than what they had going in. I believe Costco (Nasdaq: COST) and Nokia (NYSE: NOK) are good examples, which is why we bought both recently.
But this is money we don't need for years. I'm perfectly content to wait out the storm, as long as I believe the company I hold offers significant opportunity for future financial return. I don't have to ask "when." I don't know, and it should be apparent to even the dimmest bulb that no one else does, either. That doesn't keep the talking heads from jabbering away, though. I do ask "why," which means I only need to be correct eventually. That, my friends, is a comfortable position.
Bill Mann, TMFOtter on the Fool Discussion Boards
Bill Mann's career as a supermodel came to a screeching halt when he discovered the joys of bacon. Bill owns Nokia and Costco. View his profile for a complete listing. The Motley Fool has a disclosure policy.
The Rule Maker Portfolio has had a cumulative investment of $42,000. As of Aug. 27, 2002, its current value of all cash and equities is $26,455.54. This equals an internal rate of return of -15% since the launch of the portfolio in February 1998.