Thu, 30 Oct 2014
The most recent spate of jumps up and down have mostly been speculative in nature, says the Vanguard founder and former chairman.
Christine Benz: Hi, I'm Christine Benz for Morningstar.com.
I'm here at the Bogleheads Conference, and I'm happy to be joined by the event's namesake, Jack Bogle.
Jack, thank you so much for being here.
Jack Bogle: Always good to be with you, Christine, and a great occasion.
Benz: Jack, we've recently seen a lot of equity market volatility. Is it your view that perhaps investors had gotten a little bit complacent about the potential for short-term volatility in the markets?
Bogle: Well, I have long-since learned never to be surprised by anything that happens in the stock market--anything can happen. But this most recent spate of jumps up and down and around have mostly been speculative in nature. Investors aren't doing anything, I don't believe, in this market. But speculators … when there is a pieces of news, or they think there is a piece of news, they think about how other speculators will react, and they react first. So, if they think it's bad news, they will be sellers, and then the market will be driven down because that's what they do. Good news is the reverse, but it's not so frequent.
So, it's totally a speculative market. And if you don't believe that, look at the trading volumes. And I particularly look at the news speculation in the market dynamically in exchange-traded funds. The Standard & Poor's SPDR, S&P 500 ETF, has in the last week traded $160 billion of its shares, and it's a $160 billion fund. That's a 100% turnover in a week, and I guess that means it's 5,500% or 6,000% in a year, or something like that. That turnover doesn't do anybody any good, except the people who are doing the trading. And because of the costs involved, we know that investors in the ETFs, and investors in mutual funds too, basically do worse than the performance of the funds or ETFs that they own. So, it's a big speculative binge.
Investors understand, I think finally, that the value of the stock market is driven by the value of Corporate America, at least the value of the U.S. stock market is. And if it's driven by the value of Corporate America, that means Corporate America has a certain value based on dividends and dividend yields when you buy in--this is the Bogle formula--and subsequent earnings growth. And that doesn't change. If the value of Corporate America was, let's say, $20 trillion before all of this [volatility] started, at the low it was worth $18 trillion. Look, Corporate America wasn't worth $2 trillion less than it was at the beginning.
So these ups and downs are basically, as I've probably said to you before Christine, because one always likes to quote Shakespeare, like "a tale told by an idiot: full of sound and fury, signifying nothing."
Benz: How about for investors who want to do the right thing. They want to stay plugged into valuation and other fundamental factors. What do you see when you look at the market from a bottom-up valuation basis?
Bogle: Well, I don't think that anyone would say the market is cheap. It's gone up about 65% in the last decade--a pretty good decade, that's 2004 to 2014--and yet earnings have gone up 85%, even more, and dividends have gone up 100%. So, the fact that it's way up is supported somewhat by the fundamentals.
Now, if there is a fly in this particular ointment, Christine, it's that I don't trust the earnings. Corporations are pressing very, very hard to get higher and higher earnings. They are putting inadequate contributions into their pension plans, and they are pushing the accounts as hard as they can on a whole lot of small issues--and the accountants, not wanting to lose their jobs, comply. I don't like the system the way it is today. They are taking a lot of out of the hide of their employees. The big issue that came up, semi-big, about Wal-Mart eliminating health-care benefits for [some of] their part-time employees, I just don't think that's right. I think you lose something as a corporation. You can't ask your hardworking people on your payroll to be loyal to you if you are not going to be loyal to them.
So, you cut those health-care costs, and that causes the earnings to go up, and that makes the market happy and that makes the executive of all those stock options happy. I think that's a misshapen set of values.
Benz: Given the massaging of earnings, is there a way to get a valuation of the market, or do you think the numbers are misleading no matter what?
Bogle: Well, … there are two kinds of earnings. One is reported earnings, let's call them GAAP earnings (Generally Accepted Accounting Principles), and there is operating earnings, and operating earnings is the GAAP earnings without all the bad things that happened to the company--write-offs, and mergers and all that kind of thing. So Wall Street looks at price/earnings multiples ahead, future earnings, to today's price, and they use operating earnings, so they get a price/earnings multiple of about 15. If you look back at what operating earnings actually achieved in the previous 12 months, the price earnings multiple is closer to 19. So, that's not terrible.
But … for example, a company's failure to make pension fund contributions, the GAAP earnings aren't reduced. So … even the GAAP earnings are somewhat misleading. And you see this somewhat in the recent announcements by IBM. Companies have spent so much time in financial engineering, buying back stock, and those kind of thing that they get good earnings without an increase in revenues. And IBM has now kind of revealed all that. And that's a pretty good company, a solid company, I would say an honest, integrity-laded company. But the demands in the marketplace just misshape the way corporations are run. They are run too much for the short term--next month's, next quarter's, next year's earnings--and not enough for, what are we going to be doing 10, 15, 25 years from now.