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United States equities have long been skating on thin ice. It appears they
have finally collapsed through it, and are now treading water before sinking
deeper. From an historical standpoint, they have arguably been overpriced for
most if not all of the past twenty years. Their dividend yields,
price-earnings ratios, price to book values and other meaningful measures
have long ago gone beyond all safe valuation parameters. For over hundred
years, similar conditions have always signaled caution, if not danger. Why is
it now that stocks appear to be finally breaking down, and sounding the alarm
of an impending Bear Market?
There are two major guides that have endured the test of time. For at
least a few generations they indicated the limits that people were willing to
pay for ownership of common stocks. First, whenever the Dow Jones Industrial
Average’s price-earnings ratio approached or exceeded 20:1, equities normally
experienced sharp Bear Market declines. Similarly, periods when its dividend
yield plunged to 3% or less usually spelled impending disaster for the fate
of stock prices. A bit of history might be useful at this juncture.
After the disastrous Bear Market of 1929-1932 and the ensuing Great
Depression, few people ventured into common stocks. The memory of the dark
period that lasted from 1930 to the end of World War II and even later,
pervaded people’s thoughts and actions. This made them shun the stock market.
When I was young during the late-1950’s and 1960’s, the NYSE’s daily trading
volume gradually expanded. It grew from 1-2 million shares early in this era,
and ended with volumes approximating 15-18 million shares. For comparison,
during the late 1920’s, usual volumes were in the 2-4 million range. These
all paled compared with the normal multi-billion share days of today. Only
gamblers bought stocks during my youth. At best, common stocks were
considered highly speculative!
As time passed and the memory of the debacle of 1929 faded from people’s
memories, some individuals began to again accumulate equities. But, those who
“played the market” had some desire to at minimum get something for their
money. Like those before them, they limited their purchases when they had to
pay around 20 times the Dow’s yearly earnings, or when they received a paltry
3% yield on their investments. This is the reason why Bear Markets typically
ensued after P.E. ratios approached 20:1 and dividend yields fell to the 3%
range. Traders recognized that the market was overpriced, and wanted out.
The various forms of investments continually vie with one another to
attract the available capital. This includes stocks, bonds, real estate, gold
etc. The bond market is the stock market’s major competitor for money, but it
is far larger. This is the primary reason why high interest rates tend to
attract money away from equities into bonds and, conversely, money may leave
the bond market for stocks when rates are low. The critical factor is the
stock market was the decided victor in the competition for the public’s
investment dollars for the past 20 odd years, and especially for the last
six.
It is my belief that we have witnessed one of the few times in history,
when this time it was truly different! I believe the
extension of the secular Bull Market that began in 1982, was caused by a
flight of money from the bond and Treasury markets, into common stocks. The
equity advance that began in the mid-1990’s and exploded further in the years
after the 2007-08 collapse was generated by fear! It would have ended
far sooner had it not been for this reason!
Interest rates declined below historical norms in the mid-1990’s. Earlier,
the livelihoods of countless retirees and numerous others depended upon safe
investments such as bonds and annuities. They relied on the interest they
earned and counted on a decent return on their money. This allowed them to
plan their lives according to their anticipated interest payments.
That all changed in the mid-1990s! As money began to flow out of bonds and
into common stocks, equity prices embarked upon an unprecedented boom. Those
who previously were the most conservative in their investment choices felt
compelled to seek higher returns in order to survive. They could no longer
meet their usual household requirements from the money generated by their
bond and annuity investments. Their options limited, they felt forced into
heretofore believed dangerous investments such as common shares, in their
search for higher returns. The term “speculative” which people used when
referring to the stock market after the Depression was replaced with
“investment”, and then even “savings”, by the brokerage community. This lured
these poor, struggling souls and their money into the market, and fueled the
speculative boom that appears to be now unwinding.
All markets go to extremes. This is why most Bull Markets surpass the
projections of the most optimistic soothsayers to the upside, and Bear
Markets to their lows. Today, I believe the most enthusiastic bulls and the
most frightened bond investors have spent their last dollars on common stock
purchases. Together, they have driven equities beyond all rational values.
Now, the path of least resistance is downward.
Where does this leave us? I have discussed two important indications of
the grossly overpriced nature of our stock market. But there are others. One
such measure indicative of an overextended market on the verge of topping
out, is the level of indebtedness, or margin debt, that stock participants
are willing to undertake. It recently struck a never before seen height. This
surpassed those preceding the tech bubble top as well as the 2007-08 crash.
Also, since the 2009 low, the DJIA was driven higher with continually
declining volume. Healthy markets rise with increasing volume when people get
excited and rush in to buy. This confirms for me that its 2009-2015 rise was
founded on “feet of clay”. History teaches us that this is a foreboding of
far lower prices to follow. Further, the Baltic Dry Index, a measure of
global shipping rates plunged to its lowest level since it and its
predecessor were created in 1985. This tells us the depth to which the
world-wide economic slowdown has already plunged.
All of the above does not guarantee that common stocks are about to crash!
Further, it does not presage a Bear Market as great as those of 2007-08 or
1929-32. It is true that overvalued markets normally fall hard, and further
than less-extended ones. But timing is everything when it relates to markets.
One timeless stock market saw states, “don’t tell me what to buy, just tell
me when to buy it”. However, given how overextended U.S. equities are in both
time and price, I believe the odds greatly favor us witnessing significantly
lower prices before 2016 lives out its final days. Prudence dictates
avoidance of equities!
Richard S. Appel
UniqueRareCoins.com
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