Sir John Templeton is reputed to have once remarked that bull markets are born in pessimism, grow on skepticism, mature on optimism and die of euphoria. I don't know if he actually said that, since I've never seen it documented, but it sounds like him. And if he didn't say it, he should have, and I will give him credit for it anyway.
This bull market was born in the pessimism gripping the investment world after three years of declines, recession, bankruptcies and corporate scandals. The broad bottom was made in the summer of 2002, with a further intermediate bottom in October of that year and a final test in March of 2003.
Despite a 29% increase in the S&P 500 in 2003, an almost 11% increase in 2004, and now record profits, record cash flows, record returns on equity, record cash as a percentage of assets, low inflation, low interest rates, solid economic growth in the U.S. and excellent growth in most of the world, skepticism reigns.
I have seen investors more bearish than they are now, but I have never seen more angst amidst such opportunity as there is today.
I am quite optimistic about 2005. Valuations are not demanding, especially in a world of low inflation and low nominal interest rates. Mergers and acquisitions should boom this year, providing windfalls for the shareholders of takeover targets. I would expect corporate share buybacks to accelerate and dividend growth to remain strong. High returns on equity and low nominal growth mean lots of excess cash available for shareholders' benefit.
If everything is so good, why are investors so glum? Those who fail to take advantage of today's opportunities because of a sense of foreboding and fear of loss remind me of John Marcher, protagonist in Henry James' novella The Beast in the Jungle. Certain that some great misfortune was about to befall him, he failed to marry the woman he loved (lest she share his fate), or to do much of anything, only to realize too late that the great misfortune fate had in store for him was to throw away his life and opportunities because of his excessive caution and fear of the future.
Exemplifying the fears bedeviling investors today is the daily (hourly) drumbeat about the dollar and the deficits, especially the "unsustainable" current account deficit. The mantra should be familiar: the U.S. saves too little and consumes too much. We are mortgaging our future, consuming our seed corn. If foreigners stop buying our debt, the dollar will collapse and interest rates soar. The only direction for the dollar is down, and so on. It was reported that former Federal Reserve Chairman Paul Volcker puts the chances of a financial crisis at 75% over the next few years.
Is all of this or any of this right? Well, it could be. But here is the way I see it. The rest of the world saves too much and consumes too little. If the U.S. had not gone on a relative consumption binge from 1998 to today, wherein consumption went from 67% to 71% of GDP, we would have suffered not a multiyear bear market but a global deflationary depression precipitated by the Asian collapse, the Russian debt default and the failure of Long Term Capital Management.