Thursday, October 19, 2006

Achilles Heel

This may be hard to believe, but during the 70's, 80's, and into the early 90's, WalMart's stock was a juggernaut.

It was automatic. You bought it high, bought more on dips, and dollar cost averaged the rest of the time. An honest to goodness no brainer. This was a stock you could confidently recommend to Grandma; a rock solid core holding for every client. No questions asked.

In early '93 I was watching Paul Kangas on the Nightly Business Report. He was doing one of those interviews with a money manager who would come back to the show from time to time. In his previous appearance the money manager mentioned they liked WalMart. Paul pointed out it had done well since his last visit, and asked if investors should still be buying.

"No. We've sold our entire position."

I spewed whatever it was I was drinking all over the living room. The cameraman fainted. Paul Kangas looked at the guy as if he just cussed in church.

You don't SELL WalMart... you BUY WalMart!

Mr. Kangas is a consummate professional, thus he quickly regained his composure and asked his guest to explain.

"Paul, WalMart has been growing an average of 25% per year since the company went public. Their sales are quickly approaching $100 billion. We did the math and found if WalMart continues to grow at 25%, their sales will equal the GDP of the United States of America by the year 2000. Frankly, we just don't think that's gonna happen."

It was one of those rare moments that offer crystal clear clarity. Anyone watching instantly knew he was right.

A few weeks later WalMart came out with a warning that same-store sales would fall dramatically. More warnings would follow. Of course the stock was priced for perfection- and owned by everyone and their grandmother, so the sickening slide was an absolute house of pain for several years.

I was reminded of that story today while listening to a very bullish market strategist. He not only expects double digit profit growth in 07, but found no reason we couldn't continue at the same clip for the forseeable future (if you're uber bullish for 07 you can't allow for a slower rate of growth in 08 because we all know the market is a discounting mechanism).

The Achilles Heel of this market, ironically, is the simple law of large numbers.

Revergence to the mean.

The US economy is somewhere in the neighborhood of $13 Trillion, and has been growing about 3% per year during the recovery. Meanwhile, profits are up double digits umpteen quarters in a row.

We currently enjoy full employment, relatively low interest rates, high productivity, and historic corporate profit margins that are the envy of the world. The US economy has also benefitted from a staggering amount of deficit spending since the recession that followed the popping of the bubble.

It sounds great because it is great. In fact, it is phenomenal.

Until you do the math.


Anonymous Anonymous said...

you are borrowing a correct prediction on walmart to support your questionable conclusion to much. The deficit is SMALL, a couple of percent, and in a complex economy like ours both dollars and treasuries are both essential.

Will the rise in equities end? Of course they will. But any serious pull back is more likely to be after the 08 election, not before. After seeing the market extend ridiculously in the 90's please do not tell me you do not believe the market can get slighty overvalued in the next 2 to 3 years.

12:27 PM  

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