I previously wrote about Nassim Taleb’s position that investors should avoid exposure to the media. The reason is simple: journalists are primarily paid to get a readers attention while disseminating information is secondary. Taleb states, “The problem with information is not that it is diverting and generally useless, but that it is toxic.”
Oaktree Capital’s Howard Marks takes another view. Careful analysis of information presented by the media can be used to take the pulse of the market. Marks describes an article titled, “The Death of Equities” (written in 1979) which presents compelling arguments for why equities would continue to underperform going forward. However, the article actually marked the beginning of a 20-year bull cycle:
So the insightful, unemotional, contrarian investor will read an article like “The Death of Equities” and conclude that things are about as bad as they can get. And if things can’t get worse, they’ll probably get better eventually. it’s no more scientific than that. If in mid-1979 people though things could only get worse, there was no optimism to evaporate. That meant the litany of negatives actually foreshadowed something very different: The Rebirth of Equities. And that’s exactly what happened.
The S&P 500 gained 18.4% in 1979, the year “The Death of Equities” was written, and went on to average 18.9% a year for the next 20 years. There were only two down years during that span: a measly 4.9% in 1982 and 3.1% in 1990. This has to have been the best 21-year period in the modern era. Importantly, the stage had been set for this rise in 1979 by the accumulation and excessively pessimistic discounting of negatives.
Marks suggests that a similar situation may be occurring today. He suggests that sentiment is biased to the negative side at a time when stocks appear reasonably situated. The reasons include:
- Stocks have returned almost nothing over the last twelve years.
- For the first time, the 30-year return on stocks has been below the return on bonds.
- The price of the S&P 500 index is still 8% below its 2000 high, while its companies’ earnings per share have nearly doubled over the intervening period.
- Thus the P/E ratio on the S&P 500 is in the low double digits, a substantial discount from the post-World War II norm and down from the low 30s at the peak.
- Just as in 1979, institutional investors have lost interest in equities and are looking increasingly to alternatives. The love affair with equities that ran from 1979 to 1999 seems to be over.
- Allocations to equities have been cut substantially in favor of bonds and alternatives. For example, according to What I learned This Week of March 15, “The ICI reports that $408 billion was redeemed from U.S. equity mutual funds between 2007 and 2011 and $792 billion was invested in U.S. bond funds in the same period.”
Read the full memo here.