At my brother’s suggestion, I took a look at some financial tables at www.crestmontresearch.com, including one showing bull and bear stock markets since 1900. Looking at the dates, and comparing them with what I remember of American history, it seems that the long term bull and bear markets identified by Crestmont correspond with the level of trust and confidence in corporate management as agents of the public good (and the often opposite level of confidence in government), not just with cycles of the economy. The economy affects how much profit business may earn, but Crestmont bases the onsets of long-term bull and bear markets on highs and lows in the price-earnings ratio, or how much investors are willing to pay for each dollar of earnings. This depends not only on the level of inflation and the return on competing assets, but also on public perceptions of what those earnings mean for the future, and whom they will benefit. Will they ultimately be paid to stockholders, or will most of them be diverted to top executives and interlocking directors? Are the profits coming at the expense of workers and customers, and thus likely to disappear in the long run as these seek better deals elsewhere, or are customers and employees happy, creating the potential for more productivity and better sales? Are the profits even real? To me, the table is the history of business gaining and then squandering the public trust. And for the past decade, business has been doing the latter, with a reaction building that has only just begun.
The table begins in 1901, at the end of the Robber Baron era. In that era, executives and directors simply issued stock to each other, leaving ordinary investors owning less and less of the company, and entitled to less and less of the earnings. In 1901, the price-earnings ratio was 23, meaning investors were willing to pay $23 for each dollar an average company earned. According to Crestmont, however, 1901 began a bear market that ended in 1920, when the price earnings ratio had fallen to five. Although inflation was high in the latter year as a result of World War I, it is remarkable that investors has so little confidence in business and its management that they demanded a 20% return (the inverse of a price-earnings ratio of five) to invest in corporations. The years from 1901 to 1920, of course, was the Progressive Era when the sins of business were exposed and opposed.
In response, business leaders worked to regain trust by producing innovative products, raising wages as part of a social compact (Henry Ford), and joining social organizations to provide leadership in solving social problems. The result was the “Business of America is Business” era, in which corporations and their executives were seen as leading the country to prosperity, and government action was thought unnecessary. And this corresponded with a bull market, which ended with the price earnings ratio up at 22 in 1928 (and 28 in 1929). Unfortunately, it also corresponded with a growing attitude of business entitlement, which lead to some liberties being taken. These were ignored or rationalized as long as stock prices rose and people made money.
These were exposed, as part of a repeating cycle, after the crash of 1929, and some financial executives even went to jail. As hard times set in the American people believed business had failed them, and although the depression socked the rich in relatives terms even more than the poor (the distribution became more equal than at any time before or since as everyone become poor) resentment against business leadership grew. People turned to the federal government to meet their needs instead. Crestmont identifies three brief periods within the Great Depression, two bears and a bull, but by the end of it in 1941 the price-earnings ration was back down to 12.
With the “help” of new institutions such as the Securities and Exchange Commission, corporations and corporate executives cleaned up their act and worked to regain public trust. Many of the most capable executives served as “dollar a year” men during World War II, serving at a nominal salary to help organize the war effort, as their companies delivered the equipment that made victory against fascism possible. At the Worlds Fair of 1939 corporate-sponsored exhibits showcased the better world business would create for ordinary Americans and after the war, when many thought the recession would return, business actually delivered as economy boomed. The result was an era of newfound corporate respect from 1942 to 1965, when every ambitious man wanted to work for a big company and most Americans believed what the advertising industry told them. The price-earnings ratio rose from 9 in 1942 to 23 in 1965.
Then a new generation decided that much of that profit was tied up in selling the instruments of death for an increasingly unpopular war, and affordable products were produced at the expense of defiling the environment. Reformers exposed dangerous products, illegal campaign contributions, bribes abroad, and similar sleazy tactics. Business became unpopular, and people wanted government to get it under control, particularly after the lousy economy of the 1970s, my formative years. At the time, there was all kinds of paranoia about the almighty power of the corporate executives who participated in the “Trilateral Commission,” an international talking shop run by the heads of all-powerful global companies (some of whom the marketplace, in reality, was about to make go “poof”). The price earnings ratio fell from 23 in 1965 to just 9 in 1981 (and 7 in 1982). In the latter year, investors demanded a 14.7% return in year one, so little was their faith in the business future.
Then people decided government, and its union backers, had gone too far. After all, unions were striking for more and more money while everyone else was falling behind inflation. A poll at the time asked how much of an extra dollar that rich people earned the government should get, and the consensus was around 33 percent. In reality the top income tax rate for the federal tax alone was 70 percent. After Ronald Reagan’s election as President, government was identified as the problem and the types of corporations he had pitched for in the previous bull market were identified as the solution. A new breed of technology entrepreneurs became American heroes and role models. The price earnings ratio soared to 42 in 1999, implying a year one return of less than 2.5%. Why worry about what businesses are earning today when they will produce a wonderful world tomorrow? Basking in the glow, some, many, perhaps most executives came to believe their fair share of that world was greater and greater, leaving less and less for everyone else. And if they had to tell a few white lies along the way to get that share, well, that was what was required to achieve the vision.
Well we all know what happened after 2000. But it isn’t over yet, even if Eliot Spitzer is now a Governor rather than an Attorney General. Yes some laws were passed, and some people went to jail, to “restore faith in the marketplace” (thus lining up the next batch of faithful suckers). But corporate executives and directors, by and large, still feel entitled to an ever larger slice of the American pie, and feel no need to prove that everyone will be better off if the nation’s resources — our resources — are placed in their capable hands. It is self-evident to them that they deserve it, and the main goal for many still seems to be the maximization of their own personal wealth, and the hiding of how much of that is being taken from the companies they work for, while leaving a mess for the next guy to clean up. Many companies have become little more than highly leveraged gambles, with the winners taking their money off the top before the bets do (or do not) pay off. From 42 in 2000 according to Crestmont, the price-earnings ratio has fallen to 18 according to today’s Wall Street Journal. Which works out to a 5.5% return, or just a little more than treasury bills.
But today’s earnings are at peak levels relative to the economy at the expense of private-sector workers, who can only turn around and buy more and more goods and services from corporations by going deeper and deeper into debt. Which means that today’s earnings are not sustainable, and should be discounted, and the risk is much higher than for treasury bills, though I would hardly call the fiscal future of the federal government “risk free.”
Perhaps the changing political winds aren’t just about Iraq. Expect this long term bear market to continue until corporate executives feel the need to regain public trust, and then spend a long period of time re-earning it. Which means the short term bull market is unlikely to continue. I don’t have a lot of trust and confidence in business these days, and I don’t think the rate of return on anything offsets the risk of being swindled or enriching those just taking fees and providing little in return and/or cashing out at the top.
The problem is that unlike those in the Progressive, New Deal, and Great Society eras, I don’t have much faith in government either, and for many of the same reasons. Some people, such as Warren Buffett, John Bogle, and perhaps Eliot Spitzer, see the problem in one or both sets of institutions, and recognize the “blame the foreigners (trade for Dems, immigration for Reps) gambit as bogus. Those who are making out, however, seem to think that everything is just fine.