The Dow Jones industrial average is back, and so is James K. Glassman.
Glassman, of course, was the author of perhaps the most spectacularly wrong investing book ever: "Dow 36,000: The New Strategy for Profiting From the Coming Rise in the Stock Market." The book, which he wrote with Kevin Hassett, came out in 1999, when the Dow was around 11,000. The Glassman thesis was that investors had somehow, for all of history, misunderstood how truly risk-free investing in stocks was, and that they would within a few years come to this realization. This in turn, they theorized, would soon drive the Dow to more than three times its then-current levels.
The rest is history. He wrote the book near the peak of what we now know was a massive dot-com and IT bubble; the Dow fell to 7,300 by 2002. It then faced another massive sell-off in the global financial crisis, reaching a 15-year low of 6,547 four years ago tomorrow.
Glassman is back with a Bloomberg View op-ed, arguing — well, I’m not sure exactly what he’s arguing. It’s not exactly a mea culpa, except in the sense of acknowledging that the literal prediction he and Hassett made had not come true. Instead, he argues that now, 14 years after the book, Dow 36,000 “is now clearly in reach.”
He gets there not so much with an argument as with some simple math. Glassman points out that if the Dow were to rise over the next four years as much as it has, in percentage term, since its crisis-induced bottom four years ago, the stock index would reach 31,022, which is only 16 percent below Dow 36,000.
Let me phrase that a different way: If the stock market rises as much between now and 2017 as it did coming off the bottom of the worst, most catastrophic crisis in modern history, then we would then only be 16 percent below the value that Glassman thought was justified for the market way back in 1999!
True enough, I suppose. It’s also true that if The Washington Post pays me $1 billion a year for the next four years, I’ll be really wealthy.
As easy as it is to make fun of Glassman’s original prediction, it’s more useful to see why he was wrong in the first place. It boils down to two parts.
First, Glassman and Hassett argued that because the stock market had, over any long time period in recent generations, offered very high returns, it was undervalued. That is, investors should have to pay more to buy shares, given the low apparent risk they offered over longer time horizons. But the thing is, while stocks have offered consistently high returns over long time periods, they are volatile, and sometimes fall for long stretches (such as, say, the first decade of the 2000s). In the Glassman-Hassett view, investors should accept those dramatic ups and downs without any meaningful compensation in the form of higher returns.
In that sense, the 14 years since they wrote the book are perfect exemplars of what they got wrong. No one could have, in 1999, perfectly anticipated that there would be a crash in tech stocks, the Sept. 11, 2001 terrorist attacks, two major wars and a global financial crisis over the subsequent decade. But one could easily understand that just because everything had been hunky-dory in the 1980s was not a guarantee that they would remain so in the 2000s. Anybody who had paid 1999 prices for stocks — let alone the prices that Glassman would have suggested were warranted — would have lost a boatload of money simply by being naïve about what can go wrong in the world. Ironically, the rich valuations of stocks back in 1999 made it more likely that investors were being inadequately compensated for the risks they were taking on.
But the second mistake their book made is even worse. Even after arguing that “risk premia” for stocks should be much lower than they have historically been, Glassman also misused a finance concept taught to every first year corporate finance student.
When I was in business school several years ago, there was a homework assignment one day. We were given a Wall Street Journal opinion article from several years earlier making an argument about the proper valuation of the stock market. Our assignment was to critique the argument. As anyone who had been paying attention to the lesson on the “dividend discount model” could quickly figure out, the authors of that piece had made a simple computational error. They conflated the “earnings yield,” of stocks — how much in profits companies make in a year relative to their stock price — and the “dividend yield,” of how much companies actually return to their investors, rather than re-invest.
The op-ed, of course, was by Glassman and Hassett, and it was a key part of how they arrived at the conclusion that the Dow ought to be at 36,000. You as a shareholder don’t get to keep all the money companies make; some gets reinvested, which is how the firm is able to grow over time.
Given that analytical error then — and Glassman’s apparent unwillingness to see that investors should demand a premium in return for the risk of investing in stocks now — it’s hard to take his arguments too seriously.