John Hussman recently confided, “…. when the price/peakearnings multiple for the S&P 500 has been 16 or higher (the current multiple is over18), we find that the S&P 500 has experienced a loss, including dividends, averaging-6.5% over the 18-month period following the final hike of a Fed tighteningcycle.” The article, which can be found at http://tinyurl.com/y8dsek,also claims the present bull market is “unusually mature” at 4.2 years induration. The four prior bull markets with longer life spans all began with farlower price/peak earnings multiples. The 1949 bull began at multiple of 6, the 1974and 1982 bulls both at multiples of 7, and the 1990 bull began at a multiple of 11 (and ofcourse ended hypervalued at a 34 P/E). The current bull market began at a multipleof 16, and Hussman reckons, “….even from the beginning we had less room forvaluations to expand, compared with those unusually long bulls.” Thus far, thefinal rate hike was June 2006 at SPX 1272. If the historical average proves correct,a 6.5% loss from the last rate hike would place the SPX a bit below 1200 by the end of theyear.
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Sublime
The dictionary definition of sublime is “to elevate orexalt,” and it is clear that the definition fits the major indexes perfectly. But Webster’s also states “to pass directly from the solid to vapor state,”another definition that fits perfectly. Any advance from here would be on fumesalone. And incredibly, the talking heads now get excited about the merest of“corrections.” Even a 1% downside rates a headline. However, even 2%is mere noise and nothing more. Given that expectations have been modified by such asublime environment, any correction from here in the U.S. stock market is likely to be farworse than anticipated by the majority.
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A Critical Combination?
In March of 2000, total margin debt surged to $299.9 billion, thehighest ever, equating to approximately 1.67% of total stock market capitalization. As of the end of November 2006, total margin debt stood at $294.9 billion, the secondhighest ever, and about 1.57% of total capitalization. Given still higher prices forthe Dow and S&P 500 in the month of December, it is probably a good bet that margindebt has since soared to a new record, higher than at the awesome and hyper-extended March2000 peak.
We're simply amazed that so much press is devoted to the expansionin household mortgage debt and virtually none to stock margin debt. The increasein household debt is thought by many to presage a housing "collapse" yet thenear record surge in margin debt is totally ignored, although our experience less thanseven years ago offered real proof that over leveraged speculators took their toll on thestock market, leading to a halving in prices. We can only reiterate our basicpremise that a collapse in housing is remote, based on only one criteria; people do not needtheir stocks, but they do need their homes. One can easily be sold,the other cannot. Thus, our primary worry is that speculation may again haveapproached or even reached a climax in the early days of 2007.
As well, since the mutual fund cash-to-assets ratio has gone in theopposite direction, to one of the lowest readings ever at 4.0%, there would seem to bevery little elbow room for stocks when sellers finally get the upper hand as theyinevitably must. We are likely approaching a point at which employed leverage cancause great harm.
In 1987, over leverage led to a Crash. In 2000, over leverageled to a collapse. Leverage has been extremely high for the last two years. While much of the progress for the year’s gains can be attributed to the demandcreated by Exchange Traded Funds (available upon request, see page two, December 18thissue), demand has also certainly come from an additional $50.8 billion in margin loanspoured onto the fires of speculation.
The only bullish argument that can possibly counter the combinationof low relative cash and high leverage is that of absolute cash levels of mutual funds,which are still quite robust. Ironically, peak cash levels were achieved in October2000 but the S&P still fell 46% from there. Liquidity is heavily counted on bybulls as the key to higher prices going forward. However, as the savvy Jim Bianco(www.biancoresearch.com) observes, "The problem with liquidity is it is impossibleto measure and can instantly disappear. The world is only awash in liquidity untilit is not." Now, that’s a reality check!
New Market AnalysisArea
