Four of the most dangerous words in the English language are: "This time it's different." They have been used to justify many decisions and actions that fly in the face of expectations based on the past. They now are being used by many investors to justify the current level of the stock market, which, by most historic measures, is extremely high.
For example, Peter L. Bernstein, economic and investment consultant and publisher of the newsletter Economics and Portfolio Strategy, has charted the total returns on a dollar invested in the stock market from 1870 to today, adjusted for inflation.
At the end of 1996 that dollar would have grown to $5,338, a return that "stands 42% above a trendline calculated over the 119 years from 1870 to 1989 - a trendline sporting an impressive R-squared of 0.98," Mr. Bernstein writes in his latest letter.
Mr. Bernstein has noticed the market generally bounces around within one standard error of the trendline, and when it breaches either the upper or lower one standard error band, a correction eventually occurs. A year ago the index was 27% above the trendline, but 9% below the upper band. At the end of 1996, the index had climbed just above the one standard error upper band.
But he says in his newsletter, this is not a reason to panic. In three periods, the 1880s, the early 1900s and the 1950s, the market fluctuated around the upper band for extended periods of time - 15 years in the 1950s-1960s. That's the good news. The bad news is that every retreat from the upper band has taken the index all of the way down to the lower band, and sometimes beyond it.
But is this history still relevant? Maybe this time it really is different.
Let's look at world politico-economic conditions. Free or almost free markets are found everywhere except in isolated pockets (e.g., Cuba and North Korea). This has led to rapidly improving economic output and living standards in many formerly socialist countries (with Russia and a few former Soviet states the major exceptions). And free trade increasingly is becoming a reality, so those markets are much better connected.
Most countries have established or are developing free capital markets. As a result of these changes, both capital and goods flow more freely, more efficiently. At the same time, the world is undergoing massive technological revolution, increasing productivity at a rapid rate.
In most major world economies, interest rates are at reasonable levels and seem as likely to move lower as to move higher. Worldwide, there are no obvious economic excesses except perhaps stock market levels in the United States and a few other countries.
And except in isolated small pockets, the world is at peace. The Cold War is over and defense expenditures in the United States, Russia and other major economies, except China, have dropped in absolute as well as in real terms.
Has there ever in the past been an era when the efficiency of world economic activity increased so rapidly? When was there a period like this, when the economic and political outlook worldwide seems so benign?
From the 1870s to the early 1900s the world began to reap the benefits of the industrial revolution, but in that period many countries were left behind, trapped by outmoded political or economic systems until very late, e.g., Russia, China, Japan and the Austro-Hungarian Empire. The industrial revolution in that period really affected only Great Britain, France, Germany and the United States. In that period, the European nations used their new industries to strengthen their armed forces with new technology. Defense spending went up, not down.
Trade was much more restricted, and because of inefficient transportation and communications, much less efficient.
So perhaps this time it is different. Perhaps history doesn't tell us anything. Perhaps, but don't bet on it at these market levels.
