bear beard
Posts

This Chart Suggests A Bear Market Could Be Lurking

As most of you probably know, I decided back in late September last year that I wasn’t shaving until we saw another 10% correction. Although, the stock market typically sees about one per year, it’s been about three years now since we’ve seen a correction of that magnitude.

Jim Paulsen of Well Capital recently published a very interesting study on the strength and significance of this trend over the past three years. He finds that the unusual stability and persistence of the trend is a clear sign of euphoric sentiment:

Investor sentiment is currently at one of its highest levels since 1900! There have been only 14 periods since 1900 when the R-squared has risen above 90% and today it is near an all-time high record at slightly above 97%! …The stock market has typically struggled once the R-squared (investor sentiment) has risen above 90%. While the 13 previous cautionary signals since 1900 suggesting investor sentiment was too high have not been perfect, they have proved to be fairly good warning signs. For eight of the 13 signals, the stock market either immediately or fairly soon suffered a bear market (i.e., 1906, 1929, 1937, 1946, 1956, 1965, 1987, and 2007).

I decided it might be interesting to overlay Doug Short’s valuation model on top of Paulsen’s trend model (black lines at the bottom of the chart) in order to see what happened to those markets that were both overbullish and overvalued:

valuations and trend

Of the 13 prior occurrences in Paulsen’s study when stocks became overbullish, 6 also marked times when the stock market was significantly overvalued, as represented by one standard deviation above average. These times are marked with red lines on the chart – 1906, 1929, 1937, 1965, 1998 and 2007. Every one of these occurrences was followed by an almost immediate bear market. (Though the internet bubble didn’t peak in 1998, the stock market did fall 22% that year from high to low, the widely accepted definition of a bear market.)

Today marks only the 7th time since 1900 that stocks have become both extremely overbullish and extremely overvalued based on these measures. If today’s occurrence is anything like those prior 6 we should be wary of the possibility of an impending bear market.

A version of this post first appeared on The Felder Report PREMIUM.

Standard
dollarsigns
Posts

TIME Magazine Tells Reader To Go “All In” In Stocks

When I first saw this article from Time magazine I had to check the date to make sure it wasn’t an April fool’s gag (hat tip, @caret311). File this under “things you don’t see at the bottom.”

Screen Shot 2015-04-13 at 12.37.19 PM

The advice in this article is literally, ‘don’t worry about dollar cost averaging or even diversifying. Put all of your money in the stock market and do it today.’ It justifies the advice by suggesting the person has such a long time frame that this is really not very risky at all.

I hope somebody shows “Rod” what the real risk/reward setup looks like in the stock market right now. It might make him rethink going “all in.”

Screen Shot 2015-04-13 at 2.57.03 PMChart via GMO

Standard
StockTwitsRGB
Posts

StockTwits Q&A

Last week I did a question and answer session over at StockTwits. I thoroughly enjoyed it and sincerely hope it helped a few folks. Here’s a teaser:

We’ve written about Jesse Felder before. In-fact, we’re giving away $1,000 to the charity of your choice if you get this question right. Business Insider has a post up about this story too – Felder is growing his beard out until the next 10% correction. We recently sat down with Felder and talked about his beard, and thoughts on the next 10% correction:

Check out the highlights over at my Tumblr: jessefelder.tumblr.com

Standard
alfred-e-neuman
Posts

Playing Defense In The Stock Market Right Now Doesn’t Make You An Idiot

I’ve taken some flak recently for my persistently bearish views of the stock market over the past year. Rightfully so. I’ve been dead wrong. And with a record level of bulls it should come as no surprise that they’d like gloat.

But I’d like to make a few things clear. First, I’m not a perma-bear. Far from it. I was rip-snorting bullish on stocks back in early 2009 when it was very painful and lonesome to be such. And when the broader stock market presents investors with another good buying opportunity I won’t hesitate to get bullish again.

Second, just because I “worry top down” that doesn’t prevent me from successfully investing “bottom up.” I was very bullish on Apple a couple of years ago when it was also painful and lonesome to be such. I also turned very bullish on Herbalife earlier this year. Even if these trades were fully hedged they would have crushed the S&P. My worries are also one reason I’ve been bullish long bonds, another trade that has crushed the stock market.

I really find it funny that stocks are the only asset class where if you don’t own them – and today that means owning the index – when they go up you’re an idiot. What about those who didn’t own gold in the 2000’s? Or those who didn’t short financials in 2008? Or those who haven’t owned long bonds over the past few years? Why aren’t you an idiot for missing these trades?

Right now there’s a zeitgeist. It’s a mantra among investors that if you don’t own stocks 100% of the time you’re a loser. To me this is asinine. There have been plenty of times throughout history where owning stocks was a loser’s game and today has all of the makings of another one. And the zeitgeist, itself, is compelling anecdotal evidence of that!

One of the best rules anybody can learn about investing is to do nothing, absolutely nothing, unless there is something to do… I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up… I wait for a situation that is like the proverbial “shooting fish in a barrel.” -Jim Rogers in Market Wizards

I look for compelling risk/reward setups. That’s my personal style and it works for me. As I see it, the current risk/reward equation for owning an equity index fund is all risk and no reward. And some very smart people agree with the idea.

Ultimately, I still believe it’s time to play defense:

Marks became bearish on “riskier debt markets” way back in 2004. Just because he was three or four years early does that make him an idiot? Of course not. Did playing defense cost him performance during those years? Yes. But was it worth it? Absolutely. Playing defense was critical to surviving the financial crisis.

Knowing when it’s time to play defense versus offense is critical to staying power in this game. I’ve been through a number of cycles now in my career. I’m not going to simply decide one day to ignore the risks I see just because they haven’t materialized over the past 12 months. I don’t need to own an S&P 500 index fund to make money when there are plenty of other far more compelling ways to do so.

And the single reason I continue to share my bearish views on stocks is that I truly care about trying to help long-term investors avoid another painful lesson. In fact, that’s exactly what I’ve been doing here for nearly a decade now.

Standard
1950-baby-boom
Investing, Markets, Posts

This Simple Indicator Explains Persistently High Equity Valuations… For Now

In my last piece, I openly worried about a few very smart investment minds who have recently attempted to rationalize or justify the persistently high equity valuations we have seen over the past 25 years. I don’t believe that, “it’s different this time.” The modern economy doesn’t have any new magical component that makes a standard stream of cash flows any more valuable than they were 50 or 100 years ago. Nor have investors become generally more intelligent.

I think there’s a very simple explanation for the high stock market valuations since 1990: demographics. From 1981-2000, the baby boom generation came into their peak earning and investing years. Is it just coincidence that during that very same time we witnessed the largest stock market valuation bubble in history? No. In fact, there is a statistically significant correlation between demographic shifts like this and stock market valuations.

6a0133f3a4072c970b017c37501fd9970b-550wi

A few years ago a pair of research advisors to the Federal Reserve Bank of San Francisco demonstrated this link. They found that demographics (specifically, the ratio between retirement age workers to peak earning and investing age ones) is responsible for 61% of the changes in the price-to-earnings ratio of the stock market over time. Additionally, they found that when their model’s forecast p/e was off by a significant amount the real p/e consistently reverted to their forecast p/e.

el2011-26-1All this means is that there is a very strong relationship between the size of the generation that is currently in its peak earnings and investing years and the valuation of the stock market. Over the past 25 years we have seen the single largest generation in our nation’s history, the baby boomers, push stock market valuations higher than they have ever been. It’s not magic; it’s simple supply and demand (mainly demand).

According to this theory, for valuations to remain elevated the stock market needs the generations that follow the baby boomers to maintain the same population growth that the baby boom represented. We already know that this just isn’t going to happen. The generation following the baby boomers, Generation X, represents a significant deceleration in population growth. For this reason, this model forecasts a contraction of the price-to-earnings ratio over the next decade, from about 18 last year to roughly 8 in 2025.

el2011-26-2

In a piece from last December, I assumed an earnings growth rate of 3.8% over the coming decade, the historical average according to Robert Shiller, in forecasting 2025 earnings for the S&P 500 of 156.76. Apply an 8.23 p/e (forecast by the model) and you get a price level for the index of 1,290.

However, Cliff Asness has shown that earnings are very highly correlated with the level of inflation. With 10-year TIPS now implying inflation of less than 2% we can make a new earnings forecast using that as our assumed level of earnings growth. In this case, we arrive at a 2025 earnings number of 131.75. Applying an 8.23 multiple we get a price level for the index of 1,084. This would represent a decline of about 50% over the coming decade, a truly horrific prospect.

Ned Davis Research has also studied this relationship and come to a similar conclusion. The chart below comes from Davis’ terrific book, “Being Right or Making Money.”

Scan

Of course, there are many factors that influence stock prices and valuations over time and demographics is just one of them. But it’s the only one I’ve found that convincingly explains the persistently high valuations we have seen since the 1990’s. And it doesn’t support the idea that high valuations are here to stay, as some may believe. In fact, it suggests just the opposite.

Standard