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The rules of the game are
in the process of changing as the Federal Reserve begins to taper their
strategy of increasing their own portfolio holdings. This strategy
is primarily responsible for the five year long bull market and there was
no way it could last forever. The stage has been set for the end
of the bull run. The run has endured for so long and has been so
successful that even *after* five years and a spectacular run of close
to 10,000 Dow points, a significant number of analysts have called 2014
the *start* of a new secular bull market. That's the kind of silly
stuff you hear in the midst of a veritable mania.
We have updated our data through the end of 2013.
Total dollar trading volume (DTV) was $57,434,509,996,937, the third highest
in history, surpassed only in 2010 and 2011. For every dollar generated
in gross domestic product (GDP), stocks traded $3.41. Until 1997,
DTV had been above GDP only once, and that was in 1929. The ratio
has averaged $2.67 since 1997 and we have suffered two stock market crashes
with significant economic impact. It is difficult to even posit what
normal is now. Suppose we take the entire period from 1926 to 1999
and classify that as normal. Thus, we extend from three years before
the Roaring Twenties peak, through a depression, a World War, and a tremendous
expansionary phase from the end of the War until there was no doubt another
mania was in place. This is the way history usually looks.
Long multi-generation periods of simple baseline activity is not the standard.
You see pretty much the same as you see from 1926-1999. During this
period, DTV averaged only 40% of GDP. Stocks were important but were
not the end all. Clearly, they are now.
On December 5, 1996, Federal Reserve Chairman Alan
Greenspan’s speech before the American Enterprise Institute for Public
Policy Research in Washington, D.C. implied “sustained” low inflation was
responsible for “higher prices for stocks,” but asked the following:
“….how do we know when irrational
exuberance has unduly escalated asset values, which then become subject
to unexpected and prolonged contractions as they have in Japan over the
past decade?…. We as central bankers need not be concerned if a collapsing
financial asset bubble does not threaten to impair the real economy, its
production, jobs, and price stability…. we should not underestimate or
become complacent about the complexity of the interactions of asset markets
and the economy.”
Despite their own good advice, the Fed has constantly
underestimated and become complacent about the stock market, allowing risk
exposures to run to repeated new highs in the quest to create wealth.
Typically, higher risk exposures occur when the focus shifts dramatically
to the short term. When risk is low, one can sit back and wait out
the tough times. In high risk periods, one must be prepared to sell
at a moment’s notice. We have reached a point at which trading is
so short term oriented (see chart at bottom right page two) stocks no longer
trade with traditional valuations in mind. Clearly, this is how DTV
more than tripled into the 2000 peak and Nasdaq traded at a collective
In his speech, Greenspan used the Crash of ‘87
as an example of a bubble of no consequence because it did not have a lasting
impact on the economy, but 1987 was a far different beast than 1999-2000
when the Fed stood back and did nothing as tech stocks soared to impossible
prices, margin debt hit a new record and cash assets fell to a record low
as a percentage of mutual fund assets. The Fed completely underestimated
the “complexity of interactions” and their own complacency.
They were equally complacent in 2007 as mutual
fund cash reserves plunged to a new all time record low and margin debt
once again hit a new all time record high. Both instances were clear
indications of a veritable mania yet the Fed completely underestimated
the fall out to come. The current instance highlighted in our chart
at lower left is a replay of the prior two circumstances but is in reality,
a far worse situation since it is accompanied by the worst sentiment numbers
in decades, most prominently the stance of investment advisors, who briefly
moved as high as 61.6% bulls and the next week moved as low as 14.1% bears.
The gap between bulls and bears surged to as high as 43% in October 2007,
one week after the peak in prices. In 2011, the gap surged to 42%
before a correction that nearly took the Dow into bear territory.
In the last two weeks of 2013, the gap was 46%, which we believe is additional
evidence of a mania. We also believe this near universality of opinion
spells the end of the bull phase that commenced in March 2009.
What is most striking about the chart is that the
mutual fund cash ratio has remained so low for so long. At the 2000
peak, the ratio tied a 27 year old record. In 2007, the ratio briefly
fell to another new record low 3.5% and a one year moving average of the
ratio remained below 4% for 13 months. Within seven months of the
2009 bottom, the ratio was again below 4%.
The one year moving average
fell below 4% in April 2010
and has since remained there,
44 months of unbridled optimism
and record exposure to risk.
We can only reiterate our conviction this must
play out very badly. Reward is not a permanent feature of the risk/reward
equation! Over the course of history, depending upon interpretation,
stocks as measured by the Dow Industrials, have grown at a rate of 4% to
5% per year. There are times they grow at a greater pace and times
they grow at a lesser pace but the average since 1917 has been 5.19% for
all rolling 20-year periods. However, the great bull market from
1982 has had an outsized impact. For 78 years from 1917 to 1995,
stocks averaged only 4% over all 20-year rolling periods. The average
currently stands at 7.33% and has been above 5% for the longest period
in the history of our chart. There is every reason to consider that
stocks will return to the long term average and quite possibly go far below
the average as has occurred in the past. We have outlined many times
in our Pictures of a Stock Market Mania reports (see www.cross-currents.net/charts.htm)
how this might take place. A crash to Dow 12,593 in short order would
do the trick, taking our average to exactly 5%. Or, if prices simply
move sideways from a nice round number, say Dow 16,000, we’d have to wait
until October 2016. However, given the 78 year history of 20-year
rolling periods averaging 4%, perhaps that’s the case we need to examine
as the third mania in 14 years eventually comes to a screeching halt.
If that is the case, a crash to Dow 8389 is required. While an unlikely
happenstance, it is possible and would result in the third episode of prices
being cut in half. If only patience is required from Dow 16,000,
we need to wait until May 2017. Of course, the benchmarks may be
achieved with any number of iterations of price decline and patience and
that is our point.
The next bull market will likely
not occur until we see a combination of both a decline in price and the
passage of time, perhaps a few years.
Fed policy to build wealth can only work if targeted
to the long term, but their actions are clearly directed towards short
term trader objectives. Valuations are way out of line. The
S&P is trading at a P/E of 19.5. One year ago, the index
traded at a 17.5 P/E, equivalent to a drop to Dow 14,566 and coincidentally,
1% below our current correction target of Dow 14,719.
Given a still tepid economy
that has no reason to improve despite the Fed’s willingness to allow risk
to expand, we feel constrained to point to another possibility; a return
to a historic norm approaching a 15 P/E, equivalent to Dow 12,472 and coincidentally,
only one point away from our bear market target of Dow 12,471.
The following was the lead
article in our December 2, 2013 issue.
Tech Mania Redux.
For an old guy, your Editor is pretty hip.
A tech geek, a fan of all the latest gear, a former computer programmer
with professional credits, and most of all, a firm believer in capitalism.
What we don't get is the impetus for yet another mania, the third extensive
episode of insanity evidenced in 13 years. What we don't get is the
lunatic fascination with companies that lose money consistently.
What we don't get is how some of these companies are ever supposed to make
money. For instance, Twitter.
Your Editor has a Twitter account that was established
years ago just to see what his two kids were "tweeting," a practice known
to the younger set as "trolling." Not much to see. Tweets are
comprised of no more than 140 characters, not much in the way of graphics,
sometimes accompanied by a “hashtag” to indicate relevance to a certain
subject. A hashtag would be something like "#techmania" appended
to a Tweet by your Editor, such as "how in heaven's name is Twitter worth
Tweets are meant to be glanced at, as opposed to
read, but some advertisements appear as Tweets between those of persons
a member "follows." Thus, in a list of tweets from your buddies John,
Andrea, Max and a message from your gym, there might be a Tweet ad for
an upcoming video game you mentioned in a Tweet last week. While
we won't deny the ads might afford a modest penetration, they clearly cannot
be all that informative and as a result, cannot be all that attractive
to advertisers. By the way, TWTR lost $64 million in their last quarter.
Thus, despite our geekiness, we are relegated to
those with no faith in Twitter's business plan. Twitter can only
be worth $25 billion as a result of a veritable mania that places phenomenal
and unattainable valuations on companies so far in excess of what they
might actually be worth that investment in their shares must be considered
pure unadulterated madness. Let us reiterate the principal factor
about TWTR's concept. It is supposed to divert users attention for
only a brief moment, glanced at, not read. However, for full disclosure,
it is imperative to offer a more complete compendium of basic facts about
the roster of current tech mania darlings. Any insider transaction
data shown is for just the last six months.
Zynga (ZNGA) is now worth $3 billion and has lost
$614 million in last two years on $2.4 billion in revenue. Revenue
was up only 2.4% last year and in the last six months, a total of
40 insiders sold 2,144,760 shares. There were no buyers.
Amazon (AMZN) is valued at $163 billion but $143.36
billion in revenue over the last three years generated only $1.744 billion
in profits, one-third the profit margin of Walmart. WMT trades at
a 15 P/E, AMZN's expected forward P/E is 147. 25 insiders sold stock
worth roughly $88 million. There were no buyers.
Facebook (FB) now has 1.2 billion accounts, one
sixth as many people are on the face of the planet. The forward P/E
is 43.3, price to sales ratio is 16.8. The former is quite high,
the latter is absurdly high. 64 insiders have sold 9.5 million shares
worth roughly $380 million. There were no buyers.
Tumblr is the opposite of Twitter. If you
have more than 140 characters on your mind, you can write as much as you
like on Tumblr, a micro blogging site with close to 140 million blogs,
a sizable fraction of which relate to porn. Another criticism of
the site is the ability of users to violate copyrights plus spam and security
issues. According to the most recent report we have seen, Tumblr
had $13 million in revenue in 2012 and hopes to book $100 million in 2013.
The company spent $25 million to fund operations in 2012. Yahoo paid
more than ten times anticipated revenue for the company with no prospects
for profits for the foreseeable future. Good luck with that.
YHOO itself is quite pricey at 7.5 times sales. Insiders sold 11.1
million shares in the last six months. There were no buyers.
Pinterest is a photo sharing website that has grown
from 12 million users in January 2012 to 70 million today. It's not
just people anymore, it's also businesses creating pages aimed at promoting
their businesses online. Meanwhile, zero revenue has been reported
yet the company is now valued at $3.8 billion (see http://bit.ly/1biNFLb).
Pinterest is not yet a public company.
Yelp (YELP) hasn't made any money yet, but is expected
to make a little bit next year and thus trades at a forward P/E of 330.
Bear in mind "forward" is a projection and not a guarantee. Price
to sales is astronomic at a ratio of 20 to 1. The business is driven
by users posting their own reviews and ratings of local eateries and pubs
and how typical, hopes to sell advertising. The company has some
problems with some reviewers panning the competition and others loving
their own eateries, making the info less reliable. And again, a service
that is designed only for brief references by consumers. 64 insiders
have sold 5.4 million shares probably worth more than $320 million. There
were no buyers.
LinkedIn (LNKD) is worth $25.6 billion, one-third
more than it was four months ago and double what it was nine months ago.
The forward P/E is 96. Again, "forward" is only a projection and
may be way off. LNKD members create, manage, and share their professional
identity online. Recruiters and corporations pay for "enhanced" offerings
from LNKD listings accounting for roughly 53% of income. Meanwhile,
insiders have sold 2.7 million shares worth somewhere in the neighborhood
of $540 million. There were no buyers.
Perhaps the most incredible of all is Snapchat,
not yet public, but planning an offering that will place valuation at $3.5
billion. Snapchat’s claim to fame (and apparently, fortune) is a
service for mobile devices that allows one to send pictures, videos and
texts to friends that expire anywhere from one to ten seconds later, thereafter
hidden from the receiving device and deleted from Snapchat’s servers.
We have no clue where revenue will ever come from and frankly, foresee
no business model that can possibly work.
A Yahoo poll making the rounds on November 7th
when Twitter (TWTR) took its shares public asked investors if the price
would double from the initial offering price by the weekend. Fully
half said "Not very likely." Meanwhile, the shares hit $50, nearly
doubling in only seven minutes. In that brief span, TWTR gained $14
billion in market cap based on the same kind of insanity that drove the
South Sea bubble, Tulipmania, the Roaring Twenties the great tech mania
of 1999-2000 and the housing bubble in 2007. The only difference
is time compression.
Nasdaq is the primary stock exchange for all the
companies mentioned in this article and it is clear that speculation has
ramped up as prices continue to run to new highs on an almost daily basis.
The constant attraction of quick riches has resulted in a huge increase
in the ratio of Nasdaq volume to NYSE volume in recent years. Despite
two burst bubbles and the Composite Index still nearly 30% from a new all
time high, Nasdaq’s share of overall volume has roughly doubled versus
the venerable NYSE. From late 1999 into the March 2009 low, the ratio
averaged 1.24, has averaged 2.43 this year and currently stands at a robust
Edit: the chart above has been
Subsequent to the December
Speculative intensity traded
as high as 2.97.
Most importantly, our analysis shows liquidity
has fallen to its lowest level since July 2007, only three months before
one of the biggest price peaks and reversals of all time. Dating
back to at least 1997 and more likely, decades ago, liquidity has been
lower in only two months, June and July 2007.
The extent of the present mania
does not precisely match the two before but history usually rhymes, rather
than repeats exactly.
The only consequence that logically
follows is for the present bubble to burst quite soon.
We expect at least a 30% downside
The following article has been
updated from our previous report in November 2013.
Since our last report, along with prices, valuations
have gone to even wackier extremes. Below, the current chart for
a ten year average of P/E ratios made popular by Robert J. Shiller in his
book, Irrational Exuberance (see www.irrationalexuberance.com/).
The current 25.65 reading was matched only in the Roaring Twenties mania
that ended spectacularly in 1929 and the mania beginning in the late 1990s.
Now, even the broad based bull that took the Shiller P.E to sky high levels
in 1966 has been left behind in the dust. The two huge declines into
the 2003 and 2009 bottoms are patent evidence of the inevitable necessity
for fair valuations.
Dating back to 1880,
the median Shiller P/E has
been 15.91 and the mean 16.52.
The mean represents more than
35% decline in prices from today.
Is it possible?
Who would have thought that
prices would have been halved into both the 2002 and 2009 bottoms?
Yes, it is possible.
Even a modest retracement to
a Shiller P/E of 20 would result in a bear market with a 22% decline in
This should be the very least
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