[quote=zk][quote=Rich Toscano]
I should note here that I think the US stock market started out very overvalued, which complicates things. But assuming stocks were starting out reasonably valued (as many international stock markets were, imo) — then I think a 30%+ decline is a huge overreaction.
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Goldman Sachs predicts a 24% contraction in the second quarter followed by growth of 12% (3rd quarter) and 10% (fourth quarter).
I can see how the decades-long earning stream you described (and thus stock prices) would be minimally affected (or at least not 30%) in the long run by such a thing.
I guess I was under the impression that these things (huge contractions) had more…I don’t know, momentum or long-term effects than that. Or residual effects or ripple effects or indirect negative effects.
I just want to be clear that I am not denying that the economic effects could be brutal — as bad as GS predicts, or worse. My whole argument revolves around the idea of what stocks are, and what you are buying — if you view them as buying a long term stream of earnings (which is really an objectively true definition of what they are!), then even a brutal slowdown shouldn’t have that much effect on long-term fair value.
There are some caveats. One is that it will reduce the long-term earnings stream to some degree. There will be a bounceback, but not enough to offset the decline (eg, people aren’t going to go out to dinner twice in a day just because they stopped going out now). So that reduces long term earnings, but not to anywhere near the degree that markets have fallen.
The second caveat is bankruptices, which could wipe out shareholder equity. But even in the Great Depression, the bankruptcies weren’t enough to have a huge effect on long-term value. See this chart in this article for more (in the section called “Why value investing works”, which explains the chart in more detail):
So, I’m not denying that it’s going to get economically ugly. (It is). But I do think it’s important to focus on what stocks are, what you are paying for, and what impact this ugliness will have on their underlying long-term value.
Again, with the disclaimer that US stocks went into this already well above their fair value (in my view). US stock prices may revert to their long-term fair value, but the underlying value itself has probably not changed all that much due to the virus shock.
Those are two different mechanisms and it’s important to distinguish them, because if a stock market started out reasonably valued (as did international and especially emerging market stocks, in my view), then they are now very underpriced vs. their long-term fair value.
zk, did you get a chance to read that Ben Inker piece I linked to in the last post? It’s written for finance nerds so not very accessible, but it does a great job of assessing long-term stock value, including looking back at history. Check it out… if there is any jargon or concept you have questions about, post it here, I’ll be happy to try to answer.
