I recently came across a speech by a celebrated central bank leader that could scare some investors. Here are the important sections of the speech by the central banker: “Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over…
I recently came across a speech by a celebrated central bank leader that could scare some investors. Here are the important sections of the speech by the central banker:
“Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past.
But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy?
We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs, and price stability. Indeed, the sharp stock market break of 1987 had few negative consequences for the economy.
But we should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy. Thus, evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy.”
Before any of you panic at the sight of phrases such as “irrational exuberance” and “collapsing financial asset bubble,” note that the date the speech was delivered is 6 December 1996, nearly 20 years ago. And, the central banker in question is none other than Alan Greenspan, head of the Federal Reserve in the US at that time.
Greenspan was worried about asset prices – in particular, the stock market – when he made his speech, which became famous as the “irrational exuberance” speech. Some of you who are familiar with market history may realise that Greenspan’s speech was delivered in the lead-up to the dotcom boom-and-bust the US experienced in the late 1990s and early 2000s.
But here’s what is interesting. The S&P 500 index, the US’s stock market benchmark, was at 740 points back in 6 December 1996. The index is at 2,160 points today. In terms of ‘price’ alone, the S&P 500 has climbed by 5.6% annually since 6 December 1996. If we slap on a 2% dividend yield, that will bring the S&P 500’s total return to 7.6% per year. That kind of return over 20 years turns $1 into $4.30!
This reminds me of two important things about investing.
First, the legendary fund manager Peter Lynch was right when he said that “There is always something to worry about.”
Greenspan’s speech frankly looks like something that can be used to describe the financial markets we see today.
Yet, anyone who got scared out of the markets back then and failed to reinvest would have missed out on nearly 20 years of respectable gains in the market. Some individual stocks in the US have delivered way better returns, so the opportunity costs for anyone who stayed out would have been immense.
Second, time can wash out plenty of mistakes in the financial markets.
The past 20 years from 1996 to today contained plenty of jarring episodes for the US as well as global economy. For instance, there’s the 1997 Asian Financial Crisis, the aforementioned Dotcom Bubble of the late 1990s and 2000s, and the 2008-09 Great Financial Crisis. Yet, investors who stayed in have been rewarded, as Corporate America grew steadily over the years.
Singapore’s stock market has also seen similar themes play out. Take Straco Corporation Ltd (SGX: S85) for example.
The company’s shares were worth S$0.12 apiece at the start of 2007. During the Great Financial Crisis, Straco’s share price fell to a low of S$0.07 each. But today, Straco’s shares are exchanging hands at S$0.75 each. Back at the start of 2007, Straco had earnings per share of just 0.432 cents; today, the company’s earnings are 1,280% higher at 5.53 cents per share.
Now, this is not meant to say that time is a magical panacea. If stocks were bought at ridiculous valuations, not even time can save you.
Japan’s a great example. It has been more than a quarter of a century since Japanese stocks peaked in late 1989, yet the country’s market index is today less than half where it was at the peak. And, that is because Japanese stocks had incredible valuations of nearly 100 times their 10-year average earnings near the crest.
But, Japanese-level bubbles do not always appear. It’s the exception, not the norm. And so, if you’re investing and have bought stocks at reasonable valuations, then be patient and calm even in the face of price declines. Time can be a great healer of stock market wounds.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing owns shares in Straco Corporation.