Fun Article: Back to the Future [Part I]

NOTE TO READER: For the past several weeks, I have tried to think of an interesting way to frame today's financial market in historical perspective. An idea evolved. It is fantasy, but also fun. Ascall McFiggerty, named after the last Norse king of Dublin, is a fictitious (but extremely bright) Irish gent who has exceptional insight and creativity!  In fact, Ascall is so capable that he designed a time travel system – shades of H.G. Hugo's The Time Machine; or for the boomers who remember the “Rocky and Bullwinkle Show”, Mr. Peabody's “WABAC Machine” (pronounced WAY BACK machine). That is the contrivance I chose to use to take us back in time.  Therefore, be aware that the technology here is pure fantasy, while the “history” is genuine (and hopefully, helpful).

BACK TO THE FUTURE (Part I)

There I was, sitting at a table in McGonigal's Pub, overlooking the Chicago METRA train tracks, enjoying a wee pint of Guinness as I reviewed my portfolio following the close of trading on March 28, 2013. The S&P 500 Index (barely over 1569) had just topped its prior closing high (from October 9, 2007: 1565.15).  I was just a little giddy from the day's gain, but also still “antsy” about the eerily elevated stock indices.

As I sat there staring intently at my spreadsheet and charts, I suddenly sensed a presence across the table, where a moment before there had only been an empty chair. To my shock (but delight) there sat a very bright eyed and friendly-looking older man, with thick, slightly curly gray hair and a well-trimmed, matching beard …  dressed with a suggestion of 20^th century Irish fashion.  Seeing my shocked and puzzled face, he said: “You look surprised to see me, Thomas!”

“No kidding, sir!  And who, might I ask, are you?”

“Why, I am none other than Ascall McFiggerty… a fellow trader and sojourner in life.”

“Oh, that's interesting! Why are you here?”

“As ever was, Thomas, I am here to help you!”

“Help me?… Help me do what?”

“I came to help you invest and trade better, of course!”

“But, sir, I find the help I need through MarketTamer.com.  Do you know your fellow Irishman there?”

“Why of course I do. And his trusty partner Ron!”

“I see. Then what in particular brought you here today, unannounced?  And, by the way, please just call me Tom.”

“Well, Tom, with all this talk through the month of March about new closing highs in the Dow and the S&P 500, I decided I should get some first-hand historical background and perspective.  So I completed a project I have been working on in my spare time – time travel.”

“Oh c'mon, Mr. McFiggerty!  April Fools' Day isn't until next Monday. You can't travel through time!”

“The name is Ascall, Tom.  Mr. McFiggerty is my dear old father, God bless his soul. As to time travel – you may think whatever you like, Tom; but I have just come here from March in the year 2000!”

“Sure!  I'll bet!  But I'll play along. Why March of 2000?”

S&P 500 INDEX CHART: the chart to the left shows the nominal price of the S&P 500 in orange and the inflation adjusted price in blue.  Credit: from the Simple Stock Investing website. http://www.simplestockinvesting.com/SP500-historical-real-total-returns.htm

“I have not yet heard any of the TV investment reporters point out that the closing high from 2007 was only a ‘nominal’ closing high… not an inflation-adjusted closing high. Therefore, I researched the most recent inflation-adjusted high close… and it was in March of 2000, when (in today’s dollars) the S&P 500 Index stood at 2,060 – well over 25% higher than today.”

“You are kidding!”

“No, Tom, it’s true. We talk about inflation a lot, but because we are genetically programmed to adjust to our daily circumstances, we generally become numb to the full ravages of the devaluation of the dollar.  Here is just one simple example:

“Picture yourself back in 2000 (with the market at its peak) and you hold a $500,000 retirement account 100% in stocks. You could, right then, cash out and invest it all in 30-year Treasury Inflation-Protected Securities (TIPS) (yielding over 4%) and rake in an annual flow of (inflation protected) income totaling $21,000!  Can you picture doing that?”

“$21,000 a year??  You bet'cha I can picture that – sign me up!”

S&P 500 INDEX CHART: the chart to the left shows prices as adjusted relative to changes in the C.P.I.  We can see the magnitude of the inflation-adjusted difference in value between 2000 and 2013! Credit: FRED, found at http://www.research.stlouisfed.org/fred2/

“Well, my point is that today, given the ZIRP policy (Zero Interest Rate Policy) of the Federal Reserve, if you wanted to try the same strategy with your $500,000 of assets (ie. cash out of stocks and move to TIPS) you wouldn’t have nearly as much!  In fact, it would be just $2,600  — a decrease of over 85%!”

“OK, so I can’t do the same thing now that I could have done then. ZIRP is definitely hurting all retirees and savers who count on interest to help pay bills.  I pretty much knew that already.  The question is, what do I do instead?”

“OK…  in the interest of education, let me offer you one opinion. (And remember that I am not recommending any particular financial sale or purchase!)  Back in 1980, U.S. stocks were selling at approximately 30 times their estimated earnings. The ‘dividend yield’ of U.S. stocks (average dividend/average price) was a paltry 1%. Got that?

“Yes, sir!”

“Well now in 2013 (by contrast) stocks are selling for less than 14 times the projected 2013 earnings, while ‘dividend yield’ exceeds 2%.  Very significantly, the level of dividends is on the rise at the fastest rate in my memory.  Those growing dividends are vital because, over the course of the past 50 years, statistics show that stock dividends have grown between 1% and 2% faster than inflation – while the return from TIPS (by definition) only keeps up with inflation.”

“Interesting. That’s helpful, Ascall.”

“Two more brief points, Tom.  First, you yourself have written a number of times about the “Lost Decade in Stocks” between 2000 and 2010 – during which the Dow (without reinvestment of dividends) was flat. But what you have missed (or CNBC has missed) is that dividend growth within the S&P averaged 7% per year – and that occurred despite a 20% collapse in dividends during the 2007-09 financial crisis, as well as the ravages of the worst recession in seventy-five years!

“Then second, you have also written about the warnings from two major firms about bond investing: a) UBS started in February classifying bond buyers as ‘aggressive’ investors; b) TD Ameritrade’s retail division sent an article to customers entitled ‘Bonds Are Not Gravity Defying: Be Prepared’.  As investors, we need to be aware of longer-term cycles. Some experts point out that there has never been a twenty year period during which stock returns have fallen short of inflation, while (in contrast) there have been a number of twenty year periods during which bonds have fallen shy of inflation.”

“Hmm. I have been so absorbed with worry about Europe and Iran and joblessness, etc. that I didn’t stop to think quite that long-term. Most days, I just want to keep my portfolio intact through the next week!”

“Well, isn’t it ironic that, back in 2000, the stock market climbed to excessive gains (while ‘experts’ belittled warnings about unrealistic P/E multiples and ‘too far, too fast, too high’ … because (they said) ‘it is different this time’) and then the market just fell apart.  Now, bond yields have moved to all-time lows (pushing prices to new highs) and yet countless millions of average investors keep pouring funds into bonds for “safety” – ignoring the countless warnings that fixed income investments have much further to go downward than they do upward!”

“Well, I am glad you showed up today, Ascall! That gives me a lot to think about.  But, now that you’ve helped me out, how are you getting back to Ireland?”

“Ah, Thomas!  Now that would be telling, wouldn’t it!! Some secrets are worth keeping secret. Let me just offer a wee hint – I travel through a timeless network of Irish Pubs, combined with a good deal of Irish ingenuity and a dash of a little something I picked up on the upper level of Bunratty Castle!   So I’m off now.  But stay alert, because next time you show up in a pub, I might just have another visit with you – about 1987, or 2007, or maybe even the 1930’s!!”

Note: some of the data used above is from a recent piece from Professor Jeremy Siegel

Submitted by Thomas Petty

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