May 29, 2013
Excerpts from our current issue
Rationales & Targets
Back in late 1999, we were aghast to see prices
surge to levels that implied 30%-35% growth rates for tech companies as
far as the eye could see. We knew we were in a mania and we emphatically
said so in each issue. By early 2000, we knew the end was close by.
In the February 28th issue, our headline ended “Nasdaq crash now likely….”
We cited valuations, margin debt and the low cash-to-assets ratio of mutual
funds, the very same factors we have focused on here for many months.
It still took another ten days for prices to bust the bubble in 2000 and
we may still be a week or two from a similar top now, but we are as fearful
today as we were more than 13 years ago. We believe the Fed’s shift
in attitude belies the recognition (finally!) that the stock market has
indeed, gone to bubble extremes. We’d love to consider the possibility
of a soft landing for stocks, but it is not a logical outcome. It’s
been over four years since we saw any real fear. It’s not just optimism
and euphoria, it’s the complacency and smug attitude that nothing can go
wrong. We expect it will.
Investors Can't Win
Recently, we featured a chart of cyclically adjusted price earnings multiples (CAPE) and commented on Tobin’s Q Ratio, two important measures showing a hugely overvalued stock market. Dividend yields [chart is shown in our issue] for the S&P 500 point to the very same circumstance, a hugely overvalued stock market. Until 2000, dividends yields averaged a generous 4.27%, thus stocks were typically a great investment. Decent gains on an annualized basis plus dividends and even the prospect of dividend growth gave investors the best of all possible worlds. However, the modern era of manias has afforded no such generosity. S&P dividend yields since the 2000 mania top have averaged a paltry 1.85%, less than half the historic average. Of course, we live in an era of insider sales and insiders don’t want dividends paid to stockholders. Investors cannot win.
Long Term Returns
The greatest bull market in history, culminating with the tech mania, had an incredible effect on twenty-year annualized returns. Despite two of the most memorable collapses in stock market history, when stocks were cut in half from 2000-2003 and then cut in half again from 2007-2009, twenty-year annualized returns for the Dow Industrials remain quite robust, at 7.6%, ex-dividends. The historical record clearly places these returns at the very top end of a scale showing a far lower 5.17% annualized average for 96 years dating back to 1917. Clearly, the most recent period is head and shoulders above the past. In fact, during the 78 years from 1917-1995, twenty–year annualized returns averaged only 4%. Can returns remain at the elevated levels seen since 1995? Not a chance.
The simplest reason is that asset classes must compete or perish. The principal differentiating factor is risk. Thus, bonds will typically grow at a far lower rate than stocks, because the return is relatively assured. However, if stocks could be counted on to return 7.6% over all twenty-year periods, there would be almost no incentive for bonds to even exist. It is also important to understand that the huge secular bull run from the 1982 lows came only after stocks suffered through an extremely long period of underperformance from the mid-1960s, when the Dow first hit the 1000 mark. After 16 years, the Dow was at 776.
Thus, we are strongly inclined to believe that twenty-year annualized returns must decline to historically valid levels as time passes. While a correction or bear market might achieve those levels sooner, all of the scenarios we extrapolate today seem lousy. If we are correct, the future for stocks is not at all attractive. If the Dow falls to 10,000, the historical average of 5% annualized gains over twenty-year periods would not be achieved until February 2015. At Dow 12,000, it would require an additional ten weeks out to May 2015. Even at Dow 15,000, meaning a relatively sideways jaunt for prices, the journey would take us out to March 2016 before our implied norm would occur. Add into the mix the expectation from any of these points would realistically still be gains of only 5% per year and the current level of excitement and euphoria is unmistakeable; a third phase of mania, following the tech madness that ended in 2000 and the housing and stock boom that ended in 2007.
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ABOUT ALAN M. NEWMAN
Alan M. Newman has been the Editor of CROSSCURRENTS since the first issue was published in May of 1990. Mr. Newman is also a member of the Market Technician's Association and has been widely quoted for years by the financial press, media, and other newsletters and has written articles for BARRON'S.
The newsletter is published roughly every three weeks and focuses on economic and stock market commentary, often covering controversial subjects. Several proprietary technical indicators are usually featured in every issue accompanied by current interpretation. Broad samples of our work can be viewed at http://www.cross-currents.net/.
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