in government restraint and responsibility to being a straitjacket from which the government sought to escape.
THE ESTABLISHMENT OF THE FEDERAL RESERVEPeriodic liquidity crises caused by strict adherence to the gold standardprompted Congress in 1913 to pass the Federal Reserve Act that createdthe Federal Reserve System (the Fed) to be the country’s central bank.The responsibilities of the Fed were to provide an “elastic” currency,which meant that in times of banking crises the Fed would become thelender of last resort. In trying times, the central bank would provide5
When the government issued non-gold-backed money during the Civil War, the notes were called“greenbacks” because the only “backing” was the green ink printed on the notes. Yet just 20 yearsafterward, the government redeemed each and every one of those notes in gold, completely reversing the inflation of the Civil War period.
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currency to enable depositors to withdraw their deposits without forcing banks to liquidate loans and other assets.In the long run, money creation by the Fed was still constrained bythe gold standard since the government’s paper currency, or Federal Reserve notes, promised to pay a fixed amount of gold. But in the shortrun, the Federal Reserve was free to create money as long as it did notthreaten the convertibility of Federal Reserve notes to gold at the exchange rate of $20.67 per ounce. Yet the Fed was never given any guidance by Congress or by the Federal Reserve Act on how to conductmonetary policy and determine the right quantity of money.
THE FALL OF THE GOLD STANDARDThis lack of guidance had disastrous consequences just two decadeslater. In the wake of the stock crash of 1929, the world economies entereda severe downturn. Falling asset prices and failing businesses made depositors suspicious of banks’ assets. When word was received that a fewbanks were having problems meeting depositors’ withdrawals, thisstarted a bank panic.In an astounding display of institutional ineptitude, the Federal Reserve failed to provide extra reserves in order to stem the banking panicand prevent a crash of the financial system, even though the Fed had theexplicit power to do so under the Federal Reserve Act. In addition, thosedepositors who did receive their money sought even greater safety byturning their notes back to the Treasury in exchange for gold, a processthat put extreme pressure on the government’s gold reserves. The banking panic soon spread from the United States to Great Britain and Continental Europe.To prevent a steep loss of gold, Great Britain took the first step andabandoned the gold standard on September 20, 1931, suspending thepayment of gold for sterling. Eighteen months later, on April 19, 1933,the United States also suspended the gold standard as the Depressionand financial crisis worsened.The financial markets loved the government’s new-found flexibility, and the reaction of the U.S. stock market to gold’s overthrow waseven more enthusiastic than that in Great Britain. Stocks soared over 9percent on April 19 and almost 6 percent the next day. This constitutedthe greatest two-day rally in stock market history. Investors felt the government could now provide the extra liquidity needed to stabilize commodity prices and stimulate the economy, which they regarded as aboon for stocks. Bonds, however, fell, as investors feared the inflationary
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consequences of leaving the gold standard. BusinessWeek, in a positiveeditorial on the suspension, asserted:With one decisive gesture, [President Roosevelt] throws out of the window all the elaborate hocus-pocus of “defending the dollar.” He defies anancient superstition and takes his stand with the advocates of managedmoney. . . . The job now is to manage our money effectively, wisely, withself-restraint. It can be done.6
POSTDEVALUATION MONETARY POLICYIronically, while the right to redeem dollars for gold was denied U.S. citizens, it was soon reinstated for foreign central banks at the devaluedrate of $35 per ounce. As part of the Bretton Woods agreement, which setup the rules of international exchange rates after the close of World WarII, the U.S. government promised to exchange all dollars for gold held byforeign central banks at the fixed rate of $35 per ounce as long as thesecountries fixed their currency to the dollar.In the postwar period, as inflation increased and the dollar boughtless and less, gold seemed more and more attractive to foreigners. U.S.gold reserves began to dwindle, despite official claims that the UnitedStates had no plans to change its gold exchange policy at the fixed priceof $35 per ounce. As late as 1965, President Johnson stated unequivocallyin the Economic Report of the President:There can be no question of our capacity and determination to maintainthe gold value of the dollar at $35.00 per ounce. The full resources of theNation are pledged to that end.7
But this was not so. As the gold reserves dwindled, Congress removed the gold-backing requirement for U.S. currency in 1968. In nextyear’s Economic Report of the President, President Johnson declared:Myths about gold die slowly. But progress can be made—as we havedemonstrated. In 1968, the Congress ended the obsolete gold-backing requirement for our currency.8
Myths about gold? Obsolete gold-backing requirement? What aturnabout! The government finally admitted that domestic monetarypolicy would not be subject to the discipline of gold, and the guiding6
“We Start,” BusinessWeek, April 26, 1933, p. 32.Economic Report of the President, Washington, D.C.: Government Printing Office, 1965, p. 7.8Economic Report of the President, Washington, D.C.: Government Printing Office, 1969, p. 16.7
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principle of international finance and monetary policy for almost twocenturies was summarily dismissed as a relic of incorrect thinking.Despite the removal of gold backing, the United States continued toredeem gold at $35 an ounce for foreign central banks, although individuals were paying over $40 in the private markets. Seeing that the endof this exchange option was near, foreign central banks accelerated theirexchange of dollars for gold. The United States, which held almost $30billion of gold at the end of World War II, was left with $11 billion by thesummer of 1971, and hundreds of millions more were being withdrawneach month.Something dramatic had to happen. On August 15, 1971, PresidentNixon, in one of the most extraordinary actions since Roosevelt’s 1933declaration of a Bank Holiday, announced the “New Economic Policy”:Freezing wages and prices and closing the “gold window” that was enabling foreigners to exchange U.S. currency for gold. The link of gold tomoney was permanently—and irrevocably—broken.Although conservatives were shocked at that action, few investorsshed a tear for the gold standard. The stock market responded enthusiastically to Nixon’s announcement, which was also coupled with wageand price controls and higher tariffs, by jumping almost 4 percent onrecord volume. But this should not have surprised those who studiedhistory. Suspensions of the gold standard and devaluations of currencieshave witnessed some of the most dramatic stock market rallies in history. Investors agreed that gold was a monetary relic.
POSTGOLD MONETARY POLICYWith the dismantling of the gold standard, there was no longer any constraint on monetary expansion, either in the United States or in foreigncountries. The first inflationary oil shock from 1973 to 1974 caught mostof the industrialized countries off guard, and all suffered significantlyhigher inflation as governments vainly attempted to offset falling outputby expanding the money supply.Because of the inflationary policies of the Federal Reserve, theU.S. Congress tried to control monetary expansion by passing a congressional resolution in 1975 that obliged the central bank to announcemonetary growth targets. Three years later, Congress passed theHumphrey-Hawkins Act, which forced the Fed to testify on monetarypolicy before Congress twice annually and establish monetary targets. Itwas the first time since the passage of the Federal Reserve Act that Congress instructed the central bank to take the control of the stock of
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money. To this day, the financial markets closely watch the Fed chairman’s biannual testimony, which takes place in February and July.9Unfortunately, the Fed largely ignored the money targets it set inthe 1970s. The surge of inflation in 1979 brought increased pressure onthe Federal Reserve to change its policy and seriously control inflation.On Saturday, October 6, 1979, Paul Volcker, who had been appointed inApril to succeed G. William Miller as chairman of the board of the Federal Reserve System, announced a radical change in the implementationof monetary policy. No longer would the Federal Reserve set interestrates to guide policy. Instead, it would exercise control over the supplyof money without regard to interest rate movements. The market knewthat this meant sharply higher interest rates.The prospect of sharply restricted liquidity was a shock to the financial markets. Although Volcker’s Saturday night announcement(later referred to as the “Saturday Night Massacre”) did not immediately capture the popular headlines—in contrast to the abundant presscoverage devoted to Nixon’s 1971 New Economic Policy that frozeprices and closed the gold window—it roiled the financial markets.Stocks went into a tailspin, falling almost 8 percent on record volume inthe 21⁄2 days following the announcement. Stockholders shuddered atthe prospect of sharply higher interest rates that would be necessary totame inflation.The tight monetary policy of the Volcker years eventually broke theinflationary cycle. European central banks and the Bank of Japan joinedthe Fed in calling inflation “public enemy number 1,” and they consequently geared their monetary policies toward stable prices. Restrictingmoney growth proved to be the only real answer to controlling inflation.
THE FEDERAL RESERVE AND MONEY CREATIONThe process by which the Fed changes the money supply and controlscredit conditions is straightforward. When the Fed wants to increase themoney supply, it buys a government bond in the open market—a marketwhere billions of dollars in bonds are transacted every day. What isunique about the Federal Reserve is that when it buys governmentbonds in what is called an open market purchase, it pays for them by crediting the reserve account of the bank of the customer from whom the Fedbought the bond—thereby creating money. A reserve account is a deposit9
In 2000, Congress allowed to lapse the Humphrey-Hawkins Act, but legislation still required theFederal Reserve chairman to report biannually to Congress.
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a bank maintains at the Federal Reserve to satisfy reserve requirementsand facilitate check clearing.If the Federal Reserve wants to reduce the money supply, it sells government bonds from its portfolio. The buyer of these bonds instructs his orher bank to pay the seller (the Fed) from his or her account. The bank theninstructs the Fed to debit the bank’s reserve account bank, and that moneydisappears from circulation. This is called an open market sale. The buyingand selling of government bonds are called open market operations.
HOW THE FED’S ACTIONS AFFECT INTEREST RATESWe have seen that when the Federal Reserve buys and sells governmentsecurities, it influences the amount of reserves in the banking system.There is an active market for these reserves among banks, where billionsof dollars are bought and sold each day. This market is called the federalfunds market, and the interest rate at which these funds are borrowed andlent is called the federal funds rate.Although this market is called the “federal funds market,” the market is not run by the government, nor does it trade government securities. The fed funds market is a private lending market among bankswhere rates are dictated by supply and demand. However, the FederalReserve has powerful influence over the federal funds market. If the Fedbuys securities, then the supply of reserves is increased and the interestrate on federal funds goes down because banks then have ample reserves to lend. Conversely, if the Fed sells securities, the supply of reserves is reduced and the federal funds rate goes up because banksscramble for the remaining supply.Although federal funds are lent overnight so the funds rate is anovernight rate, the interest rate on federal funds forms the anchor to allother short-term interest rates. These include the prime rate, which is thebenchmark for most consumer and much commercial lending, as well asshort-term Treasury securities. The federal funds rate is the basis of literally trillions of dollars of loans and securities.Interest rates are an extremely important influence on stock pricesbecause interest rates discount the future cash flows from stocks. Therefore, bonds compete with stocks in investment portfolios. Bonds becomemore attractive when interest rates rise, so investors sell stocks until thereturns on stocks again become attractive relative to the returns onbonds. The opposite occurs when interest rates fall.Over most of the past 50 years, changes in the fed funds rates have beena very good predictor of future stock prices. This is shown in Table 11-1,
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TABLE
11–1
Federal Funds Rates and Subsequent Stock Returns (Number of Changes in Parentheses)
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which displays the return on the S&P 500 Index from the beginning ofthe month after the fed funds rate has been changed to a date 3, 6, 9, and12 months later.The effects of Fed actions on stock prices are dramatic: following increases in the fed funds rate, the subsequent returns on stocks are significantly less than average; when the fed funds rate is decreased, stockreturns are significantly higher than average. Since 1955, the total returnon stocks has been 7.5 percent in the 12 months following the 112 increases in the fed funds rate, while it has been 15.3 percent following the108 times the fed funds rate has been reduced. This compares to an average 12-month return over the period of 11.8 percent. If these resultspersist in the future, investors could significantly beat a buy-and-holdstrategy by increasing their stock holdings when the Fed is easing creditconditions and reducing stocks when the Fed is tightening.But this may not be the case. Although this strategy has workedwell from the 1950s through the 1990s, since 2000, the impact of Fed ratechanges on the stock market has been the absolute opposite of the historical record. The market has experienced negative returns followinginterest rate decreases and positive returns after increases.This is what has happened. To slow the rate of increasing inflation,the Fed initiated a series of rate hikes in June 1999 that extended throughMay 2000. But the stock market ignored these increases, and it did notstart falling in earnest until September 2001, more than 15 months afterthe Fed began raising rates. As the economy suddenly slowed, the Fedbegan easing in January 2001, but the market continued downward anddidn’t bottom until October 2002. The Fed eased a final 25 basis points(bps) in June 2003, to reach a 50-year low of 1 percent, which it maintained for one year.The market moved upward strongly in 2003, but in June 2004, asthe economy was recovering, the Fed began the first of 17 consecutive 1⁄4point increases that ended in the summer of 2006. Despite these increases, stocks continued to rise. Buying when the Fed begins to easeand selling when they start to tighten has been a poorly performingstrategy over the past decade.There could be a number of reasons why stocks are not reacting toFed rate movements as they have in the past. Perhaps investors have become so geared to watching and anticipating Fed policy that the effect ofits tightening and easing is already discounted in the market so that theimpact of Fed actions extend over a period of a few days rather thanover several months. If investors expect the Fed to do the right thing tostabilize the economy, this will be built into stock prices far before the
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Fed even begins to take its stabilizing actions. Whatever the reasons, Fedpolicy actions, at least since 2000, have not evoked the same responses inthe equity market as they had in the past.
STOCKS AS HEDGES AGAINST INFLATIONAlthough the central bank has the power to moderate (but not eliminate)the business cycle, its policy has the greatest influence on inflation. Asnoted above, the inflation of the 1970s was due to the overexpansion ofthe money supply, which was an action the central bank took in the vainhope that it could offset the contractionary effect of the OPEC oil supplyrestrictions. This expansionary monetary policy brought inflation todouble-digit levels in most industrialized economies peaking at 13 percent per year in the United States and exceeding 24 percent in the UnitedKingdom.In contrast to the returns of fixed-income assets over long periodsof time, the historical evidence is convincing that the returns on stocksover the same time periods have kept pace with inflation. Since stocksare claims on the earnings of real assets—assets whose value is intrinsically related to labor and capital—it is reasonable to expect that theirlong-term returns will not be influenced by inflation. For example, the60-year period since World War II has been the most inflationary longterm period in our history, yet the real returns on stocks have exceededthat of the previous 150 years. The ability of an asset such as stocks tomaintain its purchasing power during periods of inflation makes equities an inflation hedge.Indeed, stocks were widely praised in the 1950s as hedges againstrising consumer prices. As noted in Chapter 7, many investors stayedwith stocks, despite seeing the dividend yield on equities fall below theinterest rate on long-term bonds for the first time. In the 1970s, however,stocks were ravaged by inflation, and it became unfashionable to viewequity as an effective hedge against inflation.What does the evidence say about the effectiveness of stocks as aninflation hedge? The annual compound returns on stocks, bonds, andTreasury bills against inflation over 1-year and 30-year holding periodsfrom 1871 to 2006 are shown in Figure 11-2.These figures indicate that neither stocks nor bonds nor bills aregood short-term hedges against inflation. Short-term real returns onthese financial assets are highest when the inflation rates are low, andtheir returns fall as inflation increases. But the real returns on stocks arevirtually unaffected by the inflation rate over longer horizons. Bonds, on
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FIGURE
11–2
Holding-Period Returns and Inflation, 1871 through December 2006
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the other hand, have not matched the returns on stocks over any holdingperiod.This was the principal conclusion of Edgar L. Smith’s 1924 bookCommon Stocks as Long Term Investments. He showed that stocks outperform bonds in times of falling as well as rising prices, taking the periodafter the Civil War up to just before the turn of the century as his testcase. Smith’s results are robust and have held up to more than 80 yearsof subsequent data.
WHY STOCKS FAIL AS A SHORT-TERM INFLATION HEDGEHigher Interest RatesIf stocks represent real assets, why do they fail as a short-term inflationhedge? A popular explanation is that inflation increases interest rates onbonds, and higher interest rates on bonds depress stock prices. In otherwords, inflation must send stock prices down sufficiently to increase theirdividends or earnings yields to match the higher rates available on bonds.Indeed, this is the rationale of the “Fed model” described in Chapter 7.However, this explanation is incorrect. Certainly, expectations ofrising prices do increase interest rates. Irving Fisher, the famous earlytwentieth-century American economist, noted that lenders seek to protect themselves against inflation by adding the expected inflation to thereal interest rate that they demand from borrowers. This proposition hasbeen called the Fisher equation, after its discoverer.10But higher expected inflation also raises the expected future cashflows available to stockholders. Stocks are claims on the earnings of realassets, whether these assets are the products of machines, labor, land, orideas. Inflation raises the costs of inputs and consequently the prices ofoutputs (and those prices are in fact the measure of inflation). Therefore,future cash flows will also rise with the rise in price levels.It can be shown that when inflation impacts input and outputprices equally, the present value of the future cash flows from stocks isnot adversely affected by inflation even though interest rates rise.Higher future cash flows will offset higher interest rates so that, overtime, the price of stocks—as well as earnings and dividends—will rise at10See Irving Fisher, The Rate of Interest, New York: Macmillan, 1907. The exact Fisher equation for thenominal rate of interest is the sum of the real rate plus the expected rate of inflation plus the crossproduct of the real rate and the expected rate of inflation. If inflation is not too high, this last termcan often be ignored.
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the rate of inflation. In theory the returns from stocks will keep up withrising prices and stocks will be a complete inflation hedge.
Nonneutral Inflation: Supply-Side EffectsThe invariance of stock prices to the inflation rate holds when inflation ispurely monetary in nature, influencing costs and profits equally. But thereare many circumstances in which earnings cannot keep up with inflation.Stocks declined during the 1970s because the restriction in OPEC oil supplies dramatically increased energy costs. Firms were not able to raise theprices of their output by as much as the soaring cost of their energy inputs.Earlier in the chapter it was noted that the inflation of the 1970s wasthe result of bad monetary policy trying to offset the contractionary effectof OPEC’s oil price hikes. Yet one should not minimize the harm done byOPEC’s policies on U.S. corporate profits. U.S. manufacturers, who foryears had thrived on low energy prices, were totally unprepared to dealwith surging energy costs. The recession that followed the first OPEC oilsqueeze pummeled the stock market. Productivity plummeted, and bythe end of 1974 real stock prices, measured by the Dow Jones averages,had fallen 65 percent from the January 1966 high—the largest declinesince the crash of 1929. Pessimism ran so deep that nearly half of allAmericans in August 1974 believed the economy was heading toward adepression such as the one the nation had experienced in the 1930s.11Inflation can also harm stock prices since it increases investors’ fearsthat the central bank will take restrictive action by raising short-term realinterest rates. Such restrictive policies are often followed by an economicslowdown, which also depresses stock prices. This is another good rationale for investors to take stock prices down when inflation rises.Looking at international markets, inflation, especially in less-developed countries, is also closely linked with large government budgetdeficits and excessive government spending. Inflation therefore oftensignals that the government is taking too large a role in the economy,which leads to lower growth, lower corporate profits, and lower stockprices. In short, there are many good economic reasons why stock pricesshould fall in response to increased inflation.
Taxes on Corporate EarningsAnother very important reason why stocks are poor short-term hedgesagainst inflation is the tax code. There are two significant areas in which11
Gallup poll taken August 2 to 5, 1974.
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the U.S. tax code works to the detriment of shareholders during inflationary times: corporate profits and capital gains.Earnings are distorted by standard and accepted accounting practices that do not properly take into account the effects of inflation on corporate profits. This distortion shows up primarily in the treatment ofdepreciation, inventory valuation, and interest costs.Depreciation of plant, equipment, and other capital investments isbased on historical costs. These depreciation schedules are not adjustedfor any change in the price of capital that might occur during the life ofthe asset. During inflation, the cost of replacing capital rises, but reported depreciation does not make any adjustment for this. Therefore,depreciation allowances are understated since adequate allowances forthe rising cost of replacing capital are not reported. As a result, reporteddepreciation is understated, and reported and taxable earnings areoverstated.But depreciation is not the only source of bias in reported earnings.In calculating the cost of goods sold, firms must use the historical cost,with either “first-in-first-out” or “last-in-first-out” methods of inventoryaccounting. In an inflationary environment, the gap between historicalcosts and selling prices widens, producing inflationary profits for thefirm. These “profits” do not represent an increase in the real earningpower of the firm; instead, they represent just that part of the firm’s capital—namely, the inventory—that turns over and is realized as a monetary profit. The accounting for inventories differs from the firm’s othercapital, such as plant and equipment, which are not revalued on an ongoing basis for the purpose of calculating earnings.The Department of Commerce, the government agency responsible for gathering economic statistics, is well aware of these distortionsand has computed both a depreciation adjustment and an inventoryvaluation adjustment in the National Income and Product Accountsgoing back to 1929. But the Internal Revenue Service does not recognizeany of these adjustments for tax purposes. Firms are required to paytaxes on reported profits, even when these profits are biased upward byinflation. These biases reduce the quality of the earnings that firms report to stockholders.
Inflationary Biases in Interest CostsThere is another inflationary distortion to corporate profits that is not reported in government statistics. This distortion is based on the inflationary component of interest costs, and, in contrast to depreciation and
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inventory profits, it leads to a downward bias in reported corporate earnings during periods of inflation.Most firms raise some of their capital by issuing fixed-income assets such as bonds and bank loans. This borrowing leverages the firm’sassets since any profits above and beyond the debt service go to thestockholders. In an inflationary environment, nominal interest costs rise,even if real interest costs remain unchanged. But corporate profits arecalculated by deducting nominal interest costs, which overstates the realinterest costs to the firm. Hence, reported corporate profits are depressed compared to true economic profits.In fact, the firm is paying back debt with depreciated dollars, so thehigher nominal interest expense is exactly offset by the reduction in thereal value of the bonds and loans owed by the firm. But this reduction inthe real indebtedness is not reported in any of the earnings reports released by the firm. Unfortunately, it is not easy to quantify this earningsbias because it is not easy to separate the share of interest cost due to inflation from that due to real interest rates.
Capital Gains TaxesIn the United States, capital gains taxes are paid on the difference between the cost of an asset and the sale price, with no adjustment madefor the impact of inflation on the amount of the real gain. Thus, if assetvalues rise with inflation, the investor accrues a tax liability that must bepaid when the asset is sold, whether or not the investor has realized areal gain. This means that an asset that appreciates by less than the rateof inflation—meaning the investor is worse off in real terms—will stillbe taxed upon sale.Chapter 5 showed that the tax code has a dramatic impact on investors’ realized after-tax real returns. For even a moderate inflation rateof 3 percent, an investor with a five-year average holding period suffers a31-basis-point (hundredths of a percentage point) reduction in averageafter-tax real returns compared with the after-tax returns that he or shewould have realized if the rate of inflation had been zero. If the rate of inflation rises to 6 percent, the loss of returns is more than 65 basis points.The inflation tax has a far more severe effect on realized after-taxreal returns when the holding period is short than when it is long. Thisis because the more frequently an investor buys and sells assets, themore the government can capture the tax on nominal capital gains. Nevertheless, even for long-term investors, the capital gains tax reduces realreturns in inflationary times.
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CONCLUSIONThis chapter documents the role of money supply in the economy and financial markets. Before World War II, persistent inflation in the UnitedStates and in most industrialized countries was nonexistent. But whenduring the Great Depression the gold standard was dethroned, the control of the money supply passed directly to the central banks. And withthe dollar or other major currencies no longer being pegged to gold, itwas inflation, and not deflation, that proved to be the evil that centralbanks sought to control.The message of this chapter is that stocks are not good hedgesagainst increased inflation in the short run. However, no financial assetis. In the long run, stocks are extremely good hedges against inflation,while bonds are not. Stocks are also the best financial asset if you fearrapid inflation since many countries with high inflation can still havequite viable, if not booming, stock markets. Fixed-income assets, on theother hand, cannot protect investors from excessive government issuance of money.Inflation, although kinder to stocks than bonds, is still not good forequity holders. Fear that the Fed will fight inflation by tightening creditand raising real interest rates causes traders to sell stocks. Inflation alsooverstates corporate profits and increases the taxes firms have to pay.Furthermore, because the U.S. capital gains tax is not indexed, inflationcauses investors to pay higher taxes than they would pay in a noninflationary environment.Fortunately for shareholders, central bankers around the world arecommitted to keeping inflation low, and they have largely succeeded.But if inflation again rears its head, investors will do much better instocks than in bonds.
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CHAPTER
STOCKS AND THE BUSINESS CYCLEThe stock market has predicted nine out of the last five recessions!PA U L S A M U E L S O N , 1 9 6 6 1
I’d love to be able to predict markets and anticipate recessions, butsince that’s impossible, I’m as satisfied to search out profitable companies as Buffett is.P E T E R LY N C H , 1 9 8 9 2
A well-respected economist is about to address a large group of financialanalysts, investment advisors, and stockbrokers. There is obvious concern in the audience. The stock market has been surging to new all-timehighs almost daily, driving down dividend yields to record lows andsending price-to-earnings ratios skyward. Is this bullishness justified?The audience wants to know if the economy is really going to do wellenough to support these high stock prices.
This chapter is an adaptation of my paper “Does It Pay Stock Investors to Forecast the BusinessCycle?” in Journal of Portfolio Management, vol. 18 (Fall 1991), pp. 27–34. The material benefited significantly from discussions with Professor Paul Samuelson.1“Science and Stocks