The Intelligent Investor_ The Definitive Book on Value Investing - Benjamin Graham [34]
The 3-year price/earnings ratio for the market was lower in October 1971 than at year-end 1963 and 1968. It was about the same as in 1958, but much higher than in the early years of the long bull market. This important indicator, taken by itself, could not be construed to indicate that the market was especially high in January 1972. But when the interest yield on high-grade bonds is brought into the picture, the implications become much less favorable. The reader will note from our table that the ratio of stock returns (earnings/price) to bond returns has grown worse during the entire period, so that the January 1972 figure was less favorable to stocks, by this criterion, than in any of the previous years examined. When dividend yields are compared with bond yields we find that the relationship was completely reversed between 1948 and 1972. In the early year stocks yielded twice as much as bonds; now bonds yield twice as much, and more, than stocks.
Our final judgment is that the adverse change in the bond-yield/stock-yield ratio fully offsets the better price/earnings ratio for late 1971, based on the 3-year earnings figures. Hence our view of the early 1972 market level would tend to be the same as it was some 7 years ago—i.e., that it is an unattractive one from the standpoint of conservative investment. (This would apply to most of the 1971 price range of the DJIA: between, say, 800 and 950.)
In terms of historical market swings the 1971 picture would still appear to be one of irregular recovery from the bad setback suffered in 1969–1970. In the past such recoveries have ushered in a new stage of the recurrent and persistent bull market that began in 1949. (This was the expectation of Wall Street generally during 1971.) After the terrible experience suffered by the public buyers of low-grade common-stock offerings in the 1968–1970 cycle, it is too early (in 1971) for another twirl of the new-issue merry-go-round. Hence that dependable sign of imminent danger in the market is lacking now, as it was at the 892 level of the DJIA in November 1964, considered in our previous edition. Technically, then, the outlook would appear to favor another substantial rise far beyond the 900 DJIA level before the next serious setback or collapse. But we cannot quite leave the matter there, as perhaps we should. To us, the early-1971-market’s disregard of the harrowing experiences of less than a year before is a disquieting sign. Can such heedlessness go unpunished? We think the investor must be prepared for difficult times ahead—perhaps in the form of a fairly quick replay of the the 1969–1970 decline, or perhaps in the form of another bull-market fling, to be followed by a more catastrophic collapse.3
What Course to Follow
Turn back to what we said in the last edition, reproduced on p. 75. This is our view at the same price level—say 900—for the DJIA in early 1972 as it was in late 1964.
Commentary on Chapter 3
You’ve got to be careful if you don’t know where you’re going, ’cause you might not get there.
—Yogi Berra
Bull-Market Baloney
In this chapter, Graham shows how prophetic he can be. He looks two years ahead, foreseeing the “catastrophic” bear market of 1973–1974, in which U.S. stocks lost 37% of their value.1 He also looks more than two decades into the future, eviscerating the logic of market gurus and best-selling books that were not even on the horizon in his lifetime.
The heart of Graham’s argument is that the intelligent investor must never forecast the future exclusively by extrapolating the past. Unfortunately, that’s exactly the mistake that one pundit after another made in the 1990s. A stream of bullish books followed Wharton finance professor Jeremy Siegel’s Stocks for the Long Run (1994)—culminating, in a wild crescendo, with James Glassman