Dow 15,700

Dow 35,000 was a dream in the go-go 1990’s when the new economy had supposedly broken all of the old rules.  Dow 3,500 was a distinct fear in March, 2009 when stocks had fallen by more than half from their peak.  Dow 10,000 is the most visible reference point in the current stock market.

Every investor and business degree holder knows that stock values are fundamentally based on the expected risk-adjusted net present value of future after-tax cash flows.  They are also tempted by the “efficient markets hypothesis” that says that stock valuations incorporate all information about future returns and therefore set the present value in a rational manner.  On the other hand, they understand fluctuations, random walks, animal spirits and the history of under and over valued stock markets.

http://stockcharts.com/charts/historical/djia1900.html

http://www.investorsfriend.com/return_versus_gdp.htm

Individuals who believe that stocks return 7-8% on average in the long-run through 2-4% dividend yields and 4-6% price increases, must conclude that the stock market is inherently irrational.  It has been 30% undervalued or overvalued a majority of the last 100 years.  Overvalued 1922-31.  Undervalued 1932-54, except for 1936-37.  Undervalued 1974-86.  Overvalued 1996-2008. 

Stocks were overvalued by 137% in 1929 before tumbling to -67% undervalued in 1933.  Stocks reached an undervaluated low of -58% in 1942.  Stocks reached a new -50% undervaluation during the depths of the 1982 recession.  In 15 short years, by 1997, they reached a 57% overvaluation.  They rose to 115% overvalued in 2000, before retreating to a mere 38% overvaluation in 2003.  In 2008, stocks were 67% overvalued compared with the long-run trends.

Based on 100 years of history, the Dow Jones Industrial Average at the end of 2010 should be 9,000.  The expected value in 2020 is 15,700, providing a 5% annual valuation return and 2% dividend return.  Investors who bet against long-term average valuations do so at their own risk.

Year  Trend  Actual +/-
1910             50 62 24%
1911             53 60 14%
1912             55 60 9%
1913             58 60 4%
1914             61 58 -5%
1915             64 56 -12%
1916             67 80 19%
1917             70 80 14%
1918             74 70 -5%
1919             78 75 -3%
1920             82 100 23%
1921             86 70 -18%
1922             90 80 -11%
1923             94 90 -5%
1924             99 85 -14%
1925            104 100 -4%
1926            109 130 19%
1927            115 140 22%
1928            121 190 58%
1929            127 300 137%
1930            133 250 88%
1931            139 190 36%
1932            146 80 -45%
1933            154 50 -67%
1934            161 90 -44%
1935            170 90 -47%
1936            178 130 -27%
1937            187 175 -6%
1938            196 100 -49%
1939            206 130 -37%
1940            216 125 -42%
1941            227 125 -45%
1942            239 100 -58%
1943            250 125 -50%
1944            263 130 -51%
1945            276 160 -42%
1946            290 200 -31%
1947            304 170 -44%
1948            320 170 -47%
1949            336 175 -48%
1950            352 200 -43%
1951            370 250 -32%
1952            388 260 -33%
1953            408 260 -36%
1954            428 260 -39%
1955            450 380 -15%
1956            472 500 6%
1957            496 500 1%
1958            521 475 -9%
1959            547 525 -4%
1960            574 600 5%
1961            603 580 -4%
1962            633 700 11%
1963            664 550 -17%
1964            697 750 8%
1965            732 900 23%
1966            769 950 24%
1967            807 850 5%
1968            848 900 6%
1969            890 950 7%
1970            935 800 -14%
1971            981 850 -13%
1972         1,030 900 -13%
1973         1,082 1000 -8%
1974         1,136 850 -25%
1975         1,193 700 -41%
1976         1,252 850 -32%
1977         1,315 1000 -24%
1978         1,381 850 -38%
1979         1,450 850 -41%
1980         1,522 850 -44%
1981         1,614 950 -41%
1982         1,710 850 -50%
1983         1,813 1000 -45%
1984         1,922 1200 -38%
1985         2,037 1200 -41%
1986         2,159 1300 -40%
1987         2,289 1900 -17%
1988         2,426 1900 -22%
1989         2,572 2100 -18%
1990         2,726 2600 -5%
1991         2,890 2500 -13%
1992         3,063 3000 -2%
1993         3,247 3300 2%
1994         3,442 3700 8%
1995         3,648 3800 4%
1996         3,867 5000 29%
1997         4,099 6500 59%
1998         4,345 7800 80%
1999         4,606 9000 95%
2000         4,882 10500 115%
2001         5,175 10000 93%
2002         5,485 10000 82%
2003         5,815 8000 38%
2004         6,163 9500 54%
2005         6,533 10500 61%
2006         6,925 11000 59%
2007         7,341 12000 63%
2008         7,781 13000 67%
2009         8,248 7000 -15%
2010         8,743 10000 14%
2011         9,268    
2012         9,824    
2013       10,413    
2014       11,038    
2015       11,700    
2016       12,402    
2017       13,146    
2018       13,935    
2019       14,771    
2020       15,657    

Things Fall Apart

California voters in every county except far left San Francisco County and far right Orange County approved Proposition 14 which changes the state constitution to require the primary election to select the two highest vote recipients, without respect to their political party.

http://en.wikipedia.org/wiki/California_Proposition_14_(2010)

California may once again be on the leading edge of American history.  This change seems to be a rejection of the current primary system where candidates in both parties are required to pander to the extremists and activists before tacking back to the center to win in general elections.  Ironically, the Tea Party movement seems to be tapping some of this frustration by the average centrist voter, while at the same time pulling the Republican Party even further to the right.

In the shadow of “The Great War”, William Butler Yeats wrote:

Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world,
The blood-dimmed tide is loosed, and everywhere
The ceremony of innocence is drowned;
The best lack all conviction, while the worst
Are full of passionate intensity.

http://www.online-literature.com/donne/780/

http://en.wikipedia.org/wiki/The_Second_Coming_(poem)

The optimistic progressive consensus of 1880-1910 among the leading classes had been severely weakened by the war.  World War II shattered the last idealistic sentiments in Europe, leading to the post-war time of European community, skepticism and limited idealism.  The United States picked up the progressive banner with the New Deal, WWII, post-war global organizations and economic recovery, the cold war, New Frontier and Great Society.  Temporarily derailed by the Vietnam War, Energy Crisis and Japanese competition, the U.S. once again embraced the optimistic progressive spirit in the 1980’s, but with a distinctively right-wing flavor following the Reagan revolution.  Twenty years of economic and geopolitical progress delivered a new sense of American exceptionalism, leading to the Bush administration’s overreach in Iraq in response to the perceived terrorist threats after 9/11.   Most commentators agree that we now face a more uncertain multi-polar future (see 2/1/2010).

How did the American public reach this point where most voters clearly see that the political system does not work (see 1/26/2010)? 

Congressional and state legislator gerrymandering has played a major role.  The average voter can see that many legislators are simply incompetent party hacks with extremist, populist rhetoric, but no sense of responsibility for governing on behalf of the citizens.  The advantages of incumbents have lead to their re-election and increased voter cynicism (see 12/12/2009).    This year, unprepared voters elected Alvin Greene as the Democratic SC senate candidate and nominal Democrat, 29 year-old Tim Crawford to oppose Dan Burton.

http://en.wikipedia.org/wiki/Gerrymandering

As the financial and volunteer resources required for election have grown, the power of extremist/activist groups in both political parties has grown significantly.   As the country’s population and standard of living have grown, narrow economically rational voters have reduced their participation, thereby increasing the power of those with strong ideological views.

Citizens of all political views have become more independent, decreasing the role of many individual and institutional influencers who once promoted the center (think US News & World Report in the 1960’s).   Politicians and political parties have become far more sophisticated in identifying and capturing the resources of those with the strongest beliefs.

After the break-up of the Democratic Party’s “solid south” position following passage of the 1960’s civil rights legislation, the Republican Party developed a more philosophically consistent right wing position on all economic, military and cultural issues.  The Democrats have tried to move towards the center, but the left-right and Democratic-Republican dimensions of American politics have become synonymous for almost 40 years.  The Republicans have effectively attracted millions of Catholic, Baptist, working and middle class voters from Democratic strongholds, while the Democrats have rode demographic trends and recaptured some socially moderate and upper middle class voters on the coasts.

The modern media has returned to its 19th century roots, adopting explicit political and populist positions in order to sell advertising.  This promotes partisan posturing and coverage.

Politics no longer attracts citizen legislators with moderate views.  Political positions have very low compensation compared with other options for highly competent citizens.  The price of entering a campaign is so high that only individuals with hopes for a 20 year political career, radical idealists or the very wealthy rationally pursue elected office.

Non-party primaries, campaign finance reform, independent districting commissions and grass-roots political participation can all help to return our political system to the center, where reasonable compromises can be found for the benefit of all.  Without some structural changes, we run the risk of having the divisive and unproductive political results seen in Italy, Greece, Mexico, Venezuela, Japan and Germany.  A solid majority of the American people desire centrist solutions to our challenges.  Structural changes can help to ensure that we have a self-improving system, or at least that we do not see “things fall apart”.