In April 1998, Lawrence Lindsey, the economist and former Federal Reserve governor who is now a principal adviser to Governor George W. Bush, pulled his savings out of the stock market. He's been out ever since. At the time, the Dow Jones Industrial Average had climbed above 9,000, more than tripling in the previous eight years. Wall Street had never seen a run like it, and Lindsey was far from alone in believing it could not continue. Sixteen months earlier, Federal Reserve Chairman Alan Greenspan had issued his famous warning against the "irrational exuberance" of a market then hovering around the 6,500 mark.
Given Greenspan's influence, you almost have to give Lindsey credit for staying in the market as long as he did. And by getting out when he did, he missed the nasty downturn that sent the Dow down nearly 20 percent last summer and early fall. But he also missed the dramatic rally in the final months of 1998 and well into 1999, which saw the average rise 25 percent above the level where Lindsey had bailed out.
Many market sages have attempted to explain the extraordinary strength and duration of this bull market, but it has defied explanation by the traditional yardsticks used in the traditional ways. The most widely used of these measures is a comparison of a stock's price to its current earnings, the P/E ratio. Since ownership of a share of company's stock is defined as a claim on the company's future earnings, this is a handy number. Historically stocks have traded at an average P/E of about 14. Today they are trading at more than twice that.
Now come the veteran journalist James Glassman and economist Kevin Hassett with Dow 36,000. You would never know it from the indignant reaction the book generated well before its September publication date, but Dow 36,000 advances a reasonable argument based on data that are widely known and not seriously disputed. Indeed, what is most striking about the book, despite its radical-sounding title, is how radical it isn't.
Glassman and Hassett draw upon data assembled by Jeremy Siegel, a professor at the University of Pennsylvania, which formed the basis of Siegel's much-praised 1994 book Stocks for the Long Run. Siegel concluded, as do Glassman and Hassett, that a diversified portfolio of common stocks held for the long term (at least five years, preferably longer) is no more risky than a comparable investment in bonds.
The reason is that common stocks have averaged a yearly return (dividends plus the increase in the price of stocks) of 11 percent since 1926, about 7 percent, they estimate, better than the average return on bonds. Of course, some years the return has been much higher than 11 percent, and some years it has been much lower or even negative -- which is why stocks must be held for a long-enough period to ensure obtaining stocks' superior returns.
When the effect of compound interest is included, the difference between the return on stocks and the return on bonds (as both are currently priced) becomes truly staggering. So why have stock prices not been much, much higher relative to the prices of bonds? The answer lies in the perception, persistent through much of this century, that stocks are much more risky than bonds. The effect of this perception is a discount called the "risk premium," and Glassman and Hassett believe it has resulted in the severe and continuing undervaluation of stocks.
After all, if stocks, held for the long term, produce higher returns with no greater risk, there shouldn't be a risk premium at all. Glassman and Hassett argue that most investors have come to reject the notion of a risk premium -- which they express by buying stocks and mutual funds and holding on through thick and thin, propelling the bull market that has mystified so many in Wall Street.
These ordinary investors witnessed the frightening downturn of 1987, when the Dow Jones plunged 25 percent in a single day, and a series of other stalls and hiccups that have prompted gloom-and-doom forecasts from one end of Wall Street to the other. Each time the market has recovered smartly and soared to new highs. There has not been such a protracted bull market for a quarter century.