John Bogle on Indexing and the State of the Market "I really have not said this before but want to state it now. I do believe the S&P Index has done better than anyone has had a right to expect for a long time. Not much happens forever in the stock market." - John Bogle, IndexFunds, April 22, 1999 By Will McClatchy April 22, 1999

Jack Bogle, Chairman of The Vanguard Group and the father of index investing, doesn't like to predict market trends, but he is flatly warning investors not to depend on outsized returns from big stocks. He has little financial incentive to make such a statement, as his advice could well cause investors to exit his giant Vanguard S&P index fund.

But that is vintage Jack Bogle: integrity, genuine concern for investors, and honest appraisal of the numbers. In this recent interview he shared opinions with IndexFunds on a variety of subjects.

"There are those who argue that 100 times earnings is not excessive," he said. "I think those numbers defy credulity."

"Markets are a reflection of hope and fear. We are at a time of great hope and that is why [large cap] stocks are selling at 30 times earnings. In 1982, stocks were selling at 8 times earnings."

Just before rushing Common Sense on Mutual Funds off to the printer at the start of the year, Jack Bogle inserted some of his opinions on the current state of the market in the appendix section "Some Thoughts about the Current Stock Market as 1999 Begins."

"If the 1929 investment environment described by Graham and Dodd [in Security Analysis] sounds like today's to you (except that, in today's market, $200 buys less than $8 of earnings), I'm not surprised. Consider today's similar price-earnings ratios. Consider the seemingly parallel roles of the investment trusts of that era and the mutual funds of this era. Consider even whether the 1929 focus on portfolios, consisting of the most popular and highest-priced blue chips in an investment trust "administered by a single clerk," isn't a parallel to today's popularity of index funds modeled on the Standard & Poor's 500 Stock Index, heavily weighted as it is by growth stocks with enormous market valuations. "

For instance, the S&P would have returned more than threefold increase since 1982 without the radical earnings ratio expansion, he noted. With the expansion, that number multiplied threefold again.

"When in markets everybody believes something to be true and acts on that by buying stocks, stocks can be driven to the point where any possibility of extra returns vanishes."

Likewise he has not abandoned value.

"I have kept my Windsor [one of Vanguard's value funds] through all of this and it is having a fine year."

He is skeptical that a radical change in valuation is justified. But what about the huge economic value a technology company can bring from productivity improvements it can offer?

"There will be productivity increases that will come through. But people are paying so much that it turns out not to be worth it. The Internet is the greatest medium for unfettered price competition ever designed by the mind of man. That kind of competition is good for consumers and not producers."

But who cares about earnings when Internet stocks are rewarded by loss, not profit?

"The one inevitable thing about the markets is earnings and dividends," he maintains. He notes that Peter Lynch has been proclaiming in his recent spate of Fidelity ads that earnings drive returns.

"Surely if Fidelity's Lynch and Bogle agree, and Warren Buffet agrees with us, then who can be against us?"

Bogle on excessive mutual fund expenses:

"If mutual fund investors will ever take to the Internet to look at cost comparisons, that will finally be enough to drive expense ratios down," he said. [Jack, the staff at IndexFunds will do its best!]

Vanguard has led the charge on cost reduction for years. How much lower can costs go?

"We will continue to do our best to drive costs down," he said. "It's easier to drive down the 100 basis point ratio than the 25 basis point ratio."

"The lower priced funds have been raising their fees. We are seeing price competition, but the competition is to raise prices not lower them. Mutual fund managers want to spend more on marketing and make more."

"I understand marketing and I don't care much for it."

"The reason people [in active funds] don't like index funds is that they are low cost. They trade off the profits of managers in favor of profits of investors. Obviously managers don't like that. You can't blame them."

"I am a believer in human beings. Give them a fair shake."

So why don't more investors insist on it? Why don't they listen to top economists and believe studies that show it is inadvisable to pay large fees to attempt to outperform a market over the long run?

"Hope springs eternal," said Bogle. "Indexing is sort of dull. It flies in the face of the American way: 'I can do better.' "

And then there is the financial press, always breathlessly awaiting the latest hot active manager who is statistically no more likely to beat the market the next year than a coin flip.

"There is a vested interest in bringing up all the best funds of the past 10 years. A lot of them won't be in business in [another] 10 years."

"Don't knock mediocrity. It turns out mediocrity is pretty good. What is the point, if 1 out of 30 investors can pinpoint the managers who [will] beat the market by 2% per year, of having 30 out of 30 investors try to pick those managers?"

Bogle is not as keen on international investing as many investment professionals because he sees tremendous strength in the domestic economy.

"If you want to go abroad you can do it with an index."

And what of bonds? Should investors drop them forever, since over long periods stock returns have been consistently superior both in risk and return.

"When everybody believes it, stocks may be driven to levels where that might not be true in the future."

His long career has been remarkably focused on indexing, and he sees no change of heart.

"My convictions get more and more clear with the passage of time."