What you have to realize is that P/Es went from 17 to 7 in the '70s for a reason. Most people like dividends, or they like interest payments, because they trust that the money is coming back to them. They don't trust that they'll get paid for the money that companies retain in book value. I think that distrust grew out of the experience of the 1970s, when the great question was, “Earnings are up, how can my stock be down?” Everybody had been taught that 17 was a normal P/E and that if earnings went up, stocks would go up. In fact, a research study I've been carrying around for 30 years literally said just that.
That's why I wrote chapter 4 in my book, "Why The Market Went Down." It turns out that the critical question is why. That's what you have to focus on. When inflation and interest rates went up, market P/Es had to go down to get prospective returns up. Once I came to trust that relationship, I could trust that if companies retain earnings (as long as they don't do something dumb with them)- if they do retain earnings, those values do accrue and, at some point, the company's price will reflect those values-to a competitor, if not to the public marketplace. In fact, I have a level of confidence in that, which a whole lot of people don't have, because I've gone through the numbers. I've seen that it makes absolute sense. Based on that, I first wrote a paper about "Why The Market Went Down" in 1979 and in 1981 we told our clients that if Reagan and Volcker could get inflation under control, we would have a good decade in the stock market. All I was really saying was that P/Es could go from 7 to 17 just as they had between ’50 and ’60.
Read the complete interview
That's why I wrote chapter 4 in my book, "Why The Market Went Down." It turns out that the critical question is why. That's what you have to focus on. When inflation and interest rates went up, market P/Es had to go down to get prospective returns up. Once I came to trust that relationship, I could trust that if companies retain earnings (as long as they don't do something dumb with them)- if they do retain earnings, those values do accrue and, at some point, the company's price will reflect those values-to a competitor, if not to the public marketplace. In fact, I have a level of confidence in that, which a whole lot of people don't have, because I've gone through the numbers. I've seen that it makes absolute sense. Based on that, I first wrote a paper about "Why The Market Went Down" in 1979 and in 1981 we told our clients that if Reagan and Volcker could get inflation under control, we would have a good decade in the stock market. All I was really saying was that P/Es could go from 7 to 17 just as they had between ’50 and ’60.
Read the complete interview
