Market Indicators - Investor Sentiment

Top 811. Oct 23, 2003 3:40 PM

» SouthPacific - The latest from Comstock Partners, Inc.

Comstock Partners, Inc.
Lessons Learned and Unlearned
October 20, 2003
The lessons learned in the stock market debacle of 2000-2002 could actually result in the next decline being even greater and more violent than the recent experience. Many of us have wondered how investors could so quickly forget the lesson of the massive bubble and subsequent decline that caused investors so much money and anguish. It turns out, however, that most investors are not sorry that they participated in the bubble, but that they got out too late or not at all. The promoters of the late 1990s bubble preached the idea that the economic and market outlook was so outstanding that investors should stay in for the long-term and not try to time. The majority of investors wholeheartedly believed this idea and suffered severe losses. Looking back at the experience, many investors ran up huge profits only to see them disappear or even eat deeply into original capital. They now apparently feel that getting into the bubble was a good idea, and that the only mistake they made was not getting out in time.

If we are correct in our thinking, the implications for the market are extremely dire. It means that investors in the new ongoing bubble are far more risk averse than they were in the late 1990s and are no longer willing to hold through thick and thin. Even after the decline started in early 2000, investors refused to believe that the market could go down substantially, and consistently bragged during interviews that they would not be scared out. This, in turn, was a carryover from the previous lesson learned in 1987—that the market always comes back quickly. Today we seldom hear investors say they are in for the long-term. In our view, investors are ready to bail out quickly at any sign that the market begins to fall, or on any disappointment in the economy. This means that on any downturn the market would unravel much more quickly than in 2000-2002 and that there are likely to be numerous days of panic selling. We have always believed that investors never capitulated during the downturn, and that the bear market will not end until that happens.

There are a number of factors that can trigger a market decline soon. First, the market remains extremely overvalued. Second, stocks have already discounted a strong recovery and are not acting that well in view of the improved economic numbers. Third, a lot of the economic stimulus has already been used with fewer stimuli available in the near future. In particular, cash outs from mortgage refinancing (REFIS) were $280 billion in 2002 and up to an annualized rate of $450 billion in the second quarter of this year. However, REFIS have dropped dramatically over the past few months, and are now being reflected in reduced money growth. In the last three months the annualized rate of growth in M2 has declined from 12.5% to 1.9%, while the rate for MZM has dropped from 15.8% to 3%. In sum, we believe the market is vulnerable to an extreme downturn, and that it could happen sooner than most believe.

-- posted by SouthPacific

Top 812. Oct 24, 2003 2:04 AM

» azxcvbnm - could P/E highs be permanent?

The total number of people investing in stocks has gone up astronomically since the 1990's. It could be that P/E's will never ever go down to "historical" levels as those were set when only rich people (at a huge cost) were able to buy stocks.

This is a very difficult time to judge the market right now. It seems that it's 50-50 bulls/bears and I am not sure which side I believe in more. Yes stocks looks overvalued relative to historical norms, but those historical norms were set when people were ignorant of how good stocks were as an investment. Stocks have outpaced just about every single other form of investment, adjusted for risk, over the long term and it's clear that stocks were undervalued until the mid to late 1990's. The question is, where can I find a better risk-adjusted investment? Right now, investment property prices are sky high, and bonds yields are near historic lows.

Remember only the NASDAQ went crazy in 1999-2000, could it be that we're still undervalued? That even at these prices there's still no better investment out there than stocks? What are all your thoughts on this?

-- posted by azxcvbnm

Top 813. Oct 24, 2003 8:51 AM

» sentimentguru - market valuations

hairie - The market obviously will come back to normal valuations at some point because there is always a fundamental economic event that causes investors to realize the risk premium. In extended periods of economic expansion markets will run to overvalued levels due to excess optimism, but lack of sustainability always brings in a reality check. The next several years will be very challenging economically just to keep the system from collapsing. It is inevitable that we will see several recessions & some slow times due to excess capacity, debt, & the fact that rates have been so low that no one has had incentive to save money, only to spend & take on debt. This will be worked off over a long period of times. The market won't be able to hold its own until earnings catch up. As the economic stimulous wears off, a lot of corporate problems will arise & companies that have been using pro forma earnings that can't pay their debts will be caused to come out. We will most likely see 4000-5000 Dow over the next 3-4 years. Could come as a crash or a steady downturn, but we will not see the 66-82 period of sideways market due to the fact that interest rates have moved down for 20 years & that has caused a credit bubble. Most credit bubbles are worked off similar to the 30's with many bankrupties, This is inevitable, The only question is when.

-- posted by sentimentguru

Top 814. Oct 24, 2003 9:53 AM

» collguy - Re: market valuations

Sentiment guru-I think your analysis is a very accurate synopsis of the present situation. However, I think high energy prices will exacerbate a bad situation. Bush's solution of borrowing our way to prosperity is very misguided.

-- posted by collguy

Top 815. Oct 24, 2003 10:10 AM

» hairie31 - Crash Time ?

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We're at that dangerous time of the year...the last two weeks of October, where the 1929 and 1987 took place. Both started on a Monday, following a panicy Friday.

Also the 7.18 % decline of 1997 occurred on Monday, October 27, 1997.

It's good to be aware of the current NYSE rules regarding how they would handle another one-day crash in the market.

If the Dow Jones Industrial Average falls 10%, trading is halted on the New York Stock Exchange for 60 minutes.

If the Dow Jones Industrial Average falls 20%, trading is halted on the New York Stock Exchange for two hours.

If the Dow Jones Industrial Average falls 30%, trading is halted on the New York Stock Exchange for the day.

According to the NYSE the current 10, 20 and 30 percent decline levels, respectively, in the DJIA will be as follows:

A 900 point drop in the DJIA will halt trading for one hour if the decline occurs before 2 p.m.; for 30 minutes if before 2:30 p.m.; and have no effect between 2:30 p.m. and 4 p.m.

A 1,900 point drop will halt trading for two hours if the decline occurs before 1 p.m.; for one hour if before 2 p.m.; and for the remainder of the day if between 2 p.m. and 4 p.m.

A 2,850 point drop will halt trading for the remainder of the day regardless of when the decline occurs.

Point levels are set quarterly by using the DJIA average closing values of the previous month, rounded to the nearest 50 points. The percentage levels are adjusted quarterly on Jan. 1, April 1, July 1 and Oct. 1.

A free fall like the non-stop 22 %
decline of 1987, can't happen. The market would be closed for an hour after the first 900 point decline and then closed again for 2 hours after a 1,900 point decline.

However, overall the market could drop up to 30 % in an entire day before the exchange would close down for the day.

Of course, the crash could be spread over 2 days like in 1929.

I'm not sure what the Nasdaq rules are or if they would follow the NYSE.

We seem to be having a panicy Friday, so next Monday and Tuesday
are prime crash days.

I'm not saying the markets will crash next week, but if there is going to be a crash...historically next week is the time of the year when it has happened in the past.

-- posted by hairie31

Top 816. Oct 24, 2003 10:18 AM

» hairie31 - Re: market valuations

In response to message posted by sentimentguru:

Yes...let's make that scenario # 3

The "Slow Grind", Lower and lower
over many years ( this is Marty Zweig's recent opinion)

Or... many cyclical bull and bear makets with lower highs and lower lows.

-- posted by hairie31

Top 817. Oct 24, 2003 10:36 AM

» Normxxx - Re: could P/E highs be permanent?

In response to message posted by azxcvbnm:

Could P/E highs be permanent? It could be that P/E's will never ever go down to "historical" levels as those were set when only rich people (at a huge cost) were able to buy stocks.

That is one excellent question/observation. What everyone tends to forget is that the stock market is an auction market. That means that when people are eager to hold stocks, they go up in price; when people would rather not hold stocks, they go down in price. That is one reason that the price of stocks (as measured in P/E?) has only had a tenuous relationship with what the economy is doing.

For example, it is commonly believed that the stock market "predicts" the economy (it is even a major constituent of the ECRI index of Leading Economic Indicators). But that is not true. What happens is that prior to most economic upturns there is a large injection of liquidity pumped into the economy (curtesy of the Fed) and so cash becomes cheap relative to stocks. The opposite is generally true before most downturns.

But there are many other factors that affect stock prices (which is why one wag was able to observe, "The stock market has predicted 9 of the last 5 recessions").

The most recent downturn was a supply side, over capacity inspired recession of which the last instances were the U.S./World Wide depression in 1929-1932 and Japan in 1990-? That is why the Fed panicked-- there is no hard evidence we can control such a recession. If the economy is tanking, people want out of stocks because of specters of corporate bankruptcy, etc. Note that other "speculative" investments (e.g., "rare" books and paintings) also tend to go down in such an environment. In such a climate the shift is to "safe" and "tangible" assets-- cash, bonds, gold.

Of course, the reality and irony is that all investments, even cash, is only worth what people are willing to "pay" for them! The gold bugs insist that the speculative nature of "fiat" currency would be solved if we would only return to the *GOLD* standard; ignoring that the only thing which makes gold a store of value is the preference and predjudice of its owners. Fiat money may only be paper, but gold is only a shiny yellow metal, mostly good for ornaments (you certainly can't eat it).

But to get back to stocks. Once upon a time (prior to the '60s) people didn't pay all that much attention to P/Es. The thing that determined stock prices was Price/Dividends (P/D). After all, you can cash a dividend check and buy food with the proceeds. P/E was only used as a guide to future dividend payouts and whether the current dividend was adequately covered or not. Good stocks vied for the longest, uninterrupted dividend payout history, and the best had long, uninterrupted histories of steadily rising dividend payouts.

In those days, D/P was compared to bond yields (which were abnormally low in those relatively inflation free times-- Nixon imposed a price freeze when the inflation rate rose to the unheard of level of 5%). It was considered normal for D/P to exceed bond yield by 1-2% for a risk premium. If D/P dropped much below that, stock prices were considered overvalued (generally when D/P dropped much below 5%). Well, we all know what happened. Sometime in the late '50s to '60s D/P dropped below 5% and below the yield on bonds, never to rise again. Moreover, interest rates rose to levels never seen before (or since, thank God, over 18% by the early '80s). People forgot about dividends and now paid attention only to earnings. In those inflationary, high tax days (over 90% at the top), good (retained) earnings were considered as a tax free reinvestment of dividends.

But to finally answer your question. P/E is certainly less tangible than P/D as a measure (have you ever tried to cash an earnings check?) So there is nothing that says it can't remain "high" -- or -- conversely, drop like a rock.

-- posted by Normxxx

Top 818. Oct 25, 2003 12:13 AM

» azxcvbnm - Re: Re: could P/E highs be permanent?

In response to message posted by Normxxx:

You're absolutely right. Before 1960, an excellent, nearly infallible way to judge if the stock market was overvalued was to compare the bond yield to dividend yield. If bond yields moved higher than dividend yields on stocks, it was time to sell. But sometime in the 1950's, bond yields moved higher than dividend permanently.

Right now, thanks to 401k's and IRA's, there's just too much automatic money flowing into stocks because there's a HUGE tax advantage for doing so. The market has changed fundamentally and I believe we will not see the P/E's of the past until the baby boomers start to retire and begin to withdraw from those 401k's and IRA's. Even then we might not P/E's of 14 because, again, we were ignorant to how good of an investment stocks were. But what is "fair value"? Where is the new median, if there is one? Admittedly these are the toughest questions one can ask and I don't know the answers, but maybe some of you do?

As for the gold standard, it has many more problems than the current fiat standard we have now that allows us to create REAL worth from thin air (or from paper and ink). It would be absolutely foolish for us to go back to the constraints of any metal standard. As for gold itself, it's not a safe investment because people are increasingly seeing it as just an ornamental metal. There is no need anymore to back currency with it and governments are eventually going to sell 70% or more of their gold stores. Gold will always still have value as humans are intrinsically attracted to it, but be careful of the gold bubble.

-- posted by azxcvbnm

Top 819. Oct 25, 2003 2:52 AM

» hairie31 - John Templeton Quote

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Just got my 2004 edition of Stock Trader's Almanac. Had to read all 365 clever quotes on every days space before I end up writing all over them.

Here's the best and it's a gem:

"Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria."

Sir John Templeton

Founder of Templeton Funds, 1994.

-- posted by hairie31