Rubble Logic: What Did We Learn from the Great Stock Market Bubble?

The Financial Analysts Journal's 60th anniversary happens to coincide with the five-year anniversary of the peak of the Great Stock Market Bubble of 1999–2000. The combination of proximity in time, with just a bit of distance, makes this year an appropriate time to consider what we may have learned from this momentous event. This article suggests lessons that, if we haven't learned them, we should have. The Financial Analysts Journal's 60th anniversary happens to coincide with the five-year anniversary of the peak of the Great Stock Market Bubble of 1999–2000. The combination of proximity in time, with just a bit of distance, makes this year an appropriate time to consider what we may have learned from this momentous event. In this article, I suggest lessons for our postbubble world:Long-term average stock returns are poor forecasters of the future.Higher prices today mean lower expected returns tomorrow.Today's high stock prices have two possible meanings: (1) P/Es will revert to the mean with poor short-run returns but, then, historically more normal premiums and returns, or (2) stocks will return somewhat less in the future than they have historically.Long-term investors should not be 100 percent in stocks.International diversification is not a waste of time.Dividends are good and for some surprising reasons; when companies pay out more in dividends, their earnings tend to grow strongly faster over the next decade than when they pay less in dividends.Earnings do not grow at 10 percent a year. If we take a forecast of 2 percent long-term real EPS growth and add it to an assumed steady 2–3 percent inflation from now on, we find that history favors a 4–5 percent long-term nominal EPS growth for the future.The Fed Model must be fought.Value wins in the long term.Arbitrage has real limits; everyone votes on stock prices.Wall Street and the media are not looking out for you.You cannot trust Wall Street to compare apples to apples; beware of pro forma anything.Options issuance is an expense.Timing the market is not all bad. Short-term market timing is almost always bad (in an expected sense), but changing exposure to the stock market based on current prices with a long horizon in mind is a form of market timing that can be beneficial, particularly at extremes.The general public is full of bored, innumerate gamblers.Do-it-yourself trading is a bad idea.Despite many negative signs, I see positive portents that we have learned many of the lessons of the bubble. The idea that future long-term returns will be low has certainly gained traction. However, all is not rosy. For instance, some of the widespread arguments in favor of investing Social Security funds in the stock market reflect vestiges of Bubble Logic.We basically know how to invest. Some simple, but not easy, advice for good investing and financial planning in general includes the following: Diversify widely; keep costs low; rebalance in a disciplined fashion; spend less and save more; make less heroic assumptions about future returns; when something sounds like a free lunch, assume it is not free unless the arguments are very convincing—and then check again; stop watching the stock markets as if they were on ESPN; and work less on investing, not more.The stock market is quite wonderful. In our free capitalist society, it leads to wealth creation, democracy, and economic efficiency. So, the importance of careers in finance to society is exceptional. Doing a good job of giving advice and accurate pricing is vital, something to be proud of, and certainly too important to be left to Bubble Logic.