Monday, November 11, 2013

Stock Market: Should We Prepare For A Massive Crash?

(Drivebycuriosity) - Henry Blodget is an ambitious man. He is the founder and CEO of Business Insider, a fast growing Internet media company. It seems that he does almost everything that his company becomes one of the biggest media companies on earth.

Recently Blodget joined the group of the crash callers. Last weekend he posted an article with the title "Be Prepared For Stocks To Crash 40%-55%" (businessinsider). There he claimed "that stocks are at least 40% overvalued and, therefore, are likely to produce lousy returns over the next 10 years".

Blodget is far too smart to believe in his own fear mongering. But the article is good for his business. Since centuries the media companies have been living from the message: "Man bites dog".

In the long run stock prices follow the earnings of the companies. Since spring 2009, the end of the last recession, company profits jumped around 160%, as you can see in this graphic  (ritholtz). Stock prices on Wall Street also climbed around 160%. The rally, that started in spring 2009 - simultaneous with the beginning of the economic recovery in the US -, reflects just the rise of the company profits. So what?

The graphic also shows that in the long run the upward trend of the company profits has been accelerating. This a part of the general acceleration which has been running since the beginning of life on earth. Company profits are growing faster & faster over the time because companies are learning organism. Managements & employees are getting better over the time, meaning they are becoming more efficient and more productive. Helpful is the technological progress and the globalization which opens new markets.

I don´t claim that Blodget is 100% wrong. History shows that  crashes occur sometimes. In the year 1987 the stock market crashed around 30% - without warning and without reason. In May 2010 the Dow Jones dropped suddenly 1,000 points, but recovered totally after about 15 minutes (flash crash). Both events were phenomenas of mass psychology - like a stampede - that had just short lived influences and didn´t spoil the long run upward trend of the stock market. And the are rare. In the last 30 years we experienced just 4 crashes: 1987, 2000/01, 2008, 2010. The probability of a crash is therefore very low.

Long Term Bull Market

I claim that we are still in an early phase of a long term bull market that could be comparable to the stock market rally from 1982 till 2000 when the Dow Jones jumped from just 800 points to around 10,000 points (in spite of the crash of 1987). My claim is mainly based on three arguments:

1. Company profits will continue their solid growth. During the recessions of the years 2001/02 and in 2008 companies restructured and reduced costs significantly in order to survive. Now they are much fitter and more efficient than before. I believe that this learning process will continue and translates into a long term trend of rising company profits.

2. We are experiencing a new industrial revolution.  Advances in Internet, mobile computing, 3-d-printing, robotics, nano- & biotechnology and other fields are reducing costs, raising efficiency and creating new markets.

3. We also are having strong tailwinds from the emerging markets. The catching-up process in China, India and a lot of other countries translates into high growth in large parts of the global economy that creates continuously rising revenues & profits for global companies that are members of the S&P 500.

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