Stock market returns for 2023 to date look like this:

(tech-heavy) NASDAQ    +41.0%

(half US, half rest of the world) S&P 500    +22.9%

(best match for the US economy) Russell 2000    +13.6%

(ghost of the industrial past) Dow Jones    +12.4%. 

All in all, a very good year. 

(I might as well get my Dow rant out of the way here. Feel free to skip to the next paragraph. This is an index family created in the 19th century, whose main virtues were that they were better than nothing and that the daily figures are easy to calculate by hand. It’s otherwise far inferior to capitalization weighted indices like the others above. The main virtue I see in the Dow indices is that you know anyone who references them is clueless.)

Back in January, stock market strategists were uniformly bearish. The main competition among them was for who could produce the most dire scenario. The consensus view was the indices would plunge as 2023 unfolded, with the “winning” bearish view that they would lose a quarter of their value during the first half.

This is typically a bullish sign. The old cliche is that the bear market doesn’t end until the last bull capitulates–and in January there were no bulls to be found. And it turned out to be one this year.

for 2024?

Both today’s New York Times and Wall Street Journal financial market headlines report that the consensus among market strategists for 2024 is uniformly bullish. This sounds a lot like the other side of the cliche, that the bull market ends when the last bear capitulates. 

My own guess–and I lean heavily to the bullish side of things–is that the indices go sideways, and that relative current valuations rather than conceptions of possible future value will be the main determinants of performance. For example, taking WMT at 25x earnings vs. TGT at 18x, my guess is that TGT (which I own shares of) will do better than WMT (which I don’t). 

The Lone Ranger was a staple cowboy show on early TV. The William Tell Overture introduced it. The Ranger placing a silver bullet on a table and riding off into the sunset marked the end.

Yesterday, the Fed essentially placed the silver bullet on the table, saying that it anticipated no more rate rises and a decrease of 75bp or so in the Fed Funds rate next year. Financial market reaction was understandably positive and, equally understandably, muted. The yield on the 10-year T-note falling by 20bp to just above 4%. Stocks have gone up slightly in sympathy, with the most significant gains (as one would have expected) in the Russell 2000 index, a mid-cap index with little non-US exposure.

Brokerage house market strategists, whom I perceive to have been generally bearish in the runup to the Fed meeting, are now beginning a competition to see how can be the most bullish. There are apparently already calls for Fed Funds to fall by 150bp in 2024.

The idea that rates have peaked will certainly make for firmer footing for the overall stock market. The biggest beneficiaries, to my mind, will be: the most speculative names (the opportunity cost of holding them will fall), financials directly impacted by lower rates and the most highly financially leveraged.

Thornier stock market issues still remain, though–among them, whether retail sales are only rising because of strenuous corporate efforts to unload excess pandemic-era inventories (this is what I think); the value of urban office space (still shrinking, I think) and the loans that support them; the decline in the US GDP growth rate from, say, 3% yearly a generation ago to barely a detectable pulse today. Better schools and more immigrants are the obvious answers, but it’s unclear how achievable they may be.

Japan wasn’t exactly an emerging economy after World War II, but it’s reemergence as a world economic power starting in the 1950s has an emerging market aspect to it, in that it focused on rebuilding via a strategy of exporting well-made low-priced goods to the rest of the world. There are two general preconditions for this strategy to work: keeping the currency undervalued and a generation of workers willing to sacrifice their own economic well-being in order that their children will have a better life.

In Japan’s case, there were two other important characteristics of its economic advance:

–it was controlled by the zaibatsu, the all-male samurai-era conglomerates that were officially banned after the war, but which essentially just renamed themselves keiretsu and carried on business as usual. There was the occasional Sony (which btw seems to me to be at least as samurai today as any keiretsu member) or Nintendo, but technology transfer wasn’t the biggest feature of Japan’s recovery, and

–when it came time for the next-generation better life, the keiretsu decided to double down on feathering their own male-only, samurai-only, anti-immigration, older is smarter than younger ethos–keeping the lion’s share of the wealth created by the sacrifice of the post-war generation for themselves.

The result has been what one might easily have predicted–a generation of economic stagnation.

This is old news.

What I find interesting, though, is that over the past half-year or so I’ve been hearing lots of stories of smart young people in Japan leaving the keiretsu–or declining keiretsu job offers after college–and going to create or work for startups instead. Hard to know how this will develop–but there may end up being interesting smaller companies in Japan for the first time since the endaka (high yen) era of the 1980s..

I’ve been reading a lot of arguments lately in favor of using the ratio of the total market capitalization of publicly-traded equities in a given country to that country’s GDP as a measure of potential under-/overvaluation of that country’s stock market.

This idea comes in two flavors: measurement across countries at a given time, and examination of historical experience in a given country. There’s a potentially interesting recent article in the Journal of Financial Economics on this topic–I say “potentially” because I’ve only skimmed it

…which probably already tells you where this post is going.

Japan in 1985: across countries

In 1985, the rest of the world decided that the big reason–or at least the main one they could easily do something about–that Japan was eating everyone else’s economic lunch with its exports was that the yen was seriously undervalued, at about 240/$US 1. After a severe bout of arm-twisting of Japan in the 1985 Plaza Accords, the yen started a rapid rise to around 130/$ US 1, a mind-boggling 85% gain over three years.

In the Japanese stock market, exporters, formerly the bluest of blue chips, were crushed. But perennial-laggard domestic firms, especially those using dollar inputs, shot through the roof. The net result was that from 1985 until the Japanese central bank began to raise interest rates in 1989, the Topix index tripled in local currency terms.

US and European strategists were by and large perplexed by all this, despite the elementary economics behind it, and began to argue that the Japanese market was wildly overvalued. How so? …the man argument they came up with was that the total equity market cap of Japan was 2x GDP, while the US, the other contender for world’s largest stock market, only traded at 1x. Therefore, short Japan and buy the US.

The oddest part of this argument, to my mind, was that the stock market of the largest economy in Europe, and third-largest in the world back then, Germany, was only trading at 0.2x GDP. And the UK, stuck in neutral and lost in dreams of past glory, was trading at 1x, just like the US. Yet, none of the US bulls were arguing that Germany was a far better bet than anything else, and the UK a viable alternative to the US.

A much better performance indicator–then and now–would have been interest rates.

the US now: relative to one country’s past

In 2021, the market cap/GDP metaphor was revived, unbeknownst to me, in the argument that a total market cap of 2x GDP for the US market–twice the typical past value–was a signal of substantial overvaluation.

To my mind, this application makes somewhat more sense. It’s a pretty blunt tool, however. In theory, the first thing I would try to do to sharpen it a bit would be to separate corporate earnings derived domestically from those derived abroad–and see if there’s a trend to be found. Yes, there’s an SEC requirement that firms break this out, but sort of like product line information, companies seem to me to make a special effort to disclose as little as possible.

Anyway, a better rule would have been: in a period of rising interest rates, don’t hold unprofitable “story” stocks whose valuation is based on the promise of earnings in the far future.

I’ve just updated my Keeping Score page for November. Weak Energy and defensives in an otherwise very strong month.