HOME OF "PICTURES OF A STOCK MARKET MANIA" September 15, 2010
Alan M. Newman's Stock Market CROSSCURRENTS
Alan M. Newman, Editor
Excerpts from our September 13th issue
A Larger Perspective
Sentiment, as measured by the Investors Intelligence tally of investment advisers, turned quite negative in March of 2008. At one point, there were close to three bears for every two bulls and bears exceeded bulls for six straight weeks. Although pessimism may have been the catalyst for much of the nine week rally that took the Dow up 7.4%, those who had turned pessimistic turned out to be quite correct, just a bit ahead of the mark. Within another four weeks, they were proved insightful and before another five months had elapsed the Dow was down over 4000 points and 33% lower. Thus, we believe the recent turn of events in which this indicator has taken a turn towards pessimism, should be viewed in a larger perspective.
As well, in the 2008 timeframe, investment advisers were consistently more negative about the market’s prospects than now. Both the 26 and 52-week moving average of the bull to bear ratio hovered around 1. We seem to remember comments how the consistently somewhat pessimistic sentiment would play out well for the bulls. It did not. However, given the economic background, the 26 and 52 week ratio are currently rather optimistic at 1.5 and 1.8 (bulls to bears) respectively. For a long time, bulls have been far more in evidence than bears. It will take more than the current blip to create a bottom based on sentiment. More importantly, with mutual funds now at an all-time low of only 3.4% cash-to-assets, the larger perspective shows excessive, perhaps even euphoria.
SPECIAL SHORT TERM OFFER
YOUR COST IF YOU RENEW FOR A YEAR = ZERO! "Something Is Not Right"
Bill Pesek’s opinion piece (see http://tinyurl.com/29766qq) for Bloomberg not too long ago was an eye opener. If bullion’s surge is indeed a puzzlement for the chief of the federal reserve, our theme of uncertainty and higher prices for gold would appear to be a lock. However, there was one glaring omission in Pesek’s report, that of the effects of high frequency trading (HFT) on the equity markets, one of the most significant reasons for stocks to remain a second best alternative for investors. Another article about how Nanex analysts are taking apart the data appeared in the NY Times a few weeks ago (see http://tinyurl.com/25kwju2) and the most relevant posit was that of the founder of Nanex, who hypothesized “….the bizarre patterns might have been the result of a Wall Street version of cyberwarfare.” Clearly, as another Nanex spokesperson posited, “something is not right.”
Although the SEC is somewhat cognizant of abusive market mechanics, they are anything but fleet of foot in their response to changing conditions and are notoriously glacier like in their ability to protect U.S. investors. Bob Pisani’s piece for CNBC mentioned SEC chief Mary Shapiro’s recent comments which left zero confidence that any substantive action will be taken. If it is true (and we have no doubts on that score) that “internalized” trading and dark pools now represent 26% of all trading in a market where HFT now encompassing 56% of all transactions, then clearly, we have usurped the capital formation system to benefit those do not INVEST in our equity markets. Our principal thesis is that fair valuations cannot be present (except by chance alone) when a market is overwhelmed by short term trading. The best example of the psychological proof of our posit is the casino, where even low payout slot machines are in demand simply because the gratification can be instantaneous. While we admit there must be profitable algorithms currently utilized and in vogue amongst quants, we are also certain they change with the winds. We have established an environment in which it no longer may pay to own equity for the long term because there is no long term anymore. Something is definitely not right.
EDITORS NOTE: THE LEAD ARTICLES IN OUR SEPTEMBER 13th ISSUE WERE ABOUT OUR BULLISH VIEWS ON GOLD AND A COMMENTARY ON HIGH FREQUENCY TRADING. GOLD HIT ANOTHER NEW RECORD HIGH THE FOLLOWING DAY AND HFT WAS AGAIN IN THE NEWS. THE FULL ISSUE IS AVAILABLE UPON REQUEST.
Looking Far Ahead Although we still expect considerable downside potential into an October low for equities, we have maintained the odds for a new secular bull market are growing as the lost decade for stocks comes to an end. To be more precise, although we are unwilling to commit 100% to the bull thesis after our downside targets are met, we do believe stocks will rebound quite nicely and rally strongly in 2011. Our caveat is the next secular bull market for stocks will in no way resemble the last secular bull market for stocks and beyond 2011, progress for years to come is likely to be dull, uninspiring, boring and plodding.Below, we present a really long term perspective, one which clearly implies a far more modest future is in store than the glory years from 1982 to 2000. The 20-year annualized rate of gain is now 7.5%, the highest since November 2008 and well in excess of what history has shown to be sustainable. As seen below, 20-year returns have been below 5% more than half the time and have averaged only 5.1%, despite the tremendous bull market from 1982 to 2000. Moreover, during a vast history of 78 years from 1917 to 1995, the 20-year return was only 4% annualized and this long history implies that we should expect a return to at least the 5% level, probably the 4% level and perhaps even an eventual return to the 0.7% level achieved back in 1982. Impossible? Remember, the Dow has actually lost ground over the last ten years. A glance at the circled bottoms in the 1920s, 1930s and the 1940s clearly suggests the 0.7% level is possible.
If our thesis is correct, investors will require a great deal of patience and will have to accept that the last secular bull market was an aberration, not to be repeated in our lifetimes. For instance, let us assume three “targets” in which either the 5%, 4% or 0.7% levels are eventually achieved for 20-year annualized returns. Furthermore, let us assume three scenarios in which these “targets” are fulfilled at either Dow 8400, Dow 10,500 or Dow 12,000. Dow 8400 represents the top of the range for our October low forecast. Dow 10,500 is roughly the current level. Dow 12,000 represents the assumption of a relatively bullish target. Unfortunately, no matter how we slice and dice the possibilities, it will likely require extraordinary patience for investors if any of the scenarios are to occur. Clearly, the Dow 8400 scenario represents a negative return for investors. Dow 10,500 represents a zero return. Unfortunately, even our Dow 12,000 scenario does not represent anything more than modest gains. For instance, the scenario representing 20-year annualized gains at the 5% level in May 2015 at Dow 12,000 results in an annualized rate of gain from today of only 2.9%.
While we cannot deny the possibility of much higher prices eventually in the next secular bull market, there seems little likelihood that 20-year annualized returns can be sustained anywhere near current levels and will fall, perhaps rapidly, to more reasonable levels. The twin manias have come and gone and if history is any guide at all, we should be on the track towards normal.
INTERESTED IN PERSPECTIVES YOU'LL FIND NOWHERE ELSE?
ENROLL IN OUR FREE TRIAL. NO OBLIGATION.
WATCH THIS SPACE FOR MORE COMMENTARY ON OCTOBER 6th.
WHY NOT REQUEST A FREE TRIAL?
Powerful Commentary. Unique Perspectives.
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/.
Subscription rates are now $189 for one year and $100 for six months. A FREE 3 issue trial subscription is available by emailing us (click the "free trial" link above). Please note: trial requests must include name, address and phone number and must originate from the email address the trial is to be delivered. Trials are only available by Email (.pdf files). U.S. Mail subscriptions are available but include a nominal surcharge for postage and handling.
