Everything but the US Stock Market Has Already Peaked
There’s one holiday you may have missed in the festive season just passed: December 11, when the Fed released its quarterly Z.1 report. It was a sort of Christmas for finance nerds like me. The Z.1 is a treasure trove of macroeconomic data for the United States. Want to know if households are getting richer or poorer? Or if people are saving more? Z.1 has the answers At 175 pages, the Z.1 is a monster. So I’m happy to have Jesse Felder, editor of The Felder Report, join us today to distill some of its most important data down into useful stock market indicators.The Felder Report
Jesse is a new contributor to this space, but I’ve been following his work for a while. As you’ll read, he does the kind of data-driven, fact-focused analysis that we at Casey Research love. Jesse has been managing money for over 20 years, having worked for Bear Stearns and then cofounded a multibillion-dollar hedge fund. Today he runs a family office Read on for Jesse’s take on what the new Z.1 data are telling us about the US stock market.
Everything but the US Stock Market Has Already Peaked By Jesse Felder The new Z.1 report came out today, so let’s update many of the indicators I’ve been sharing over the past few months. What should be worrisome to market watchers here is that we now have a host of significant indicators that look like they may have formed important peaks and begun to roll over. We will need to see at least a couple more quarters’ worth of data to be sure, but this is certainly something to keep an eye on. First let’s take a peek at Warren Buffett’s favorite valuation yardstick. (See “How to Time the Market Like Warren Buffett” for a look at one way I use this indicator.) It actually peaked last quarter and saw a small retracement in Q3. This indicator is 83% negatively correlated with future 10-year returns in stocks (the higher the reading, the lower forward returns), and its current reading implies a -0.88% annual rate of return over the coming decade. The 10-year Treasury at 2.2% looks fairly attractive in comparisonHow to Time the Market Like Warren Buffett
Next we can look at the household percentage of financial assets allocated to equities. This indicator is even more negatively correlated to future 10-year returns, at about 90%. It has also pulled back just a bit from the peak it made in Q2. Its current reading implies a forward return of about 2.8% per year over the coming decade, slightly better than the 10-year Treasury.
Finally, comparing the current level of the S&P 500 to its long-term regression trend, we can see that the only other time in history stocks were this overbought was at the height of the Internet bubble. This measure is 74% correlated to future returns—not as high as the first two indicators, but not bad, either. It also looks at the largest data sample of the three, so I believe it’s worth including. Its current reading suggests stocks should return just 0.74% per year over the coming decade.
Blending the three forecasts together, we get a 0.89% annual return forecast for the stock market over the coming decade. A straight comparison to 10-year Treasuries yielding 2.2% shows them to be more attractive right now. Hell, even 5-year Treasuries are paying 1.6%, nearly double our model’s forecast. All in all, this looks to be the second-worst time to own equities in history.second-worst time to own equities in history Still, the stock market’s uptrend remains intact, as all of the major indexes currently trade above their 200-day moving averages. But as I’ve noted recently, there are plenty of signs that the trend is not as healthy as bulls would hope. The advance/decline line, new highs/new lows, and the percentage of stocks trading above their 200-day moving averages are all diverging fairly dramatically from the new highs recently set by the indexes. These are serious red flags.noted recently
And now that our market cap-to-GDP and household equities indicators have possibly peaked—along with high-yield spreads (inverted), margin debt, and corporate profit margins—there seems to be a very good possibility that the uptrend could be tested in short order. In fact, I went back and looked at the instances when these three indicators peaked around the same time during the past 15 years or so, and I found that they coincided pretty neatly with the major stock market peakshigh-yield spreadsmargin debtcorporate profit margins
So the uptrend may still be intact, but I think we have a plethora (yes, a plethora) of evidence that suggests its days may be numbered. Foreign equities have mostly given up their uptrends over the past few months, and commodities, led by the oil crash, look even uglier. How much longer can the US stock market swim against the tide?given up their uptrends
Ten Investing Gems from Peter Lynch’s One Up on Wall Street by Vishal Khandelwal This article was originally published in June 2012. I was re- reading Lynch’s book and thought of re-publishing these amazing lessons again. Apart from Benjamin Graham’s The Intelligent Investor, there is no better book to get started for beginners than Peter Lynch’s One Up On Wall Street.Benjamin GrahamThe Intelligent InvestorPeter LynchOne Up On Wall Street The easy-going and simplistic stock picking style discussed in this book brought Lynch great success in his profession as a fund manager at the US mutual fund company, Fidelity. The best part about this book is that it’s low on number crunching but high on anecdotal stories. Moreover, readers are given a clear picture on how to get off to a good start in the stock market.
One Up On Wall StreetOne Up On Wall Street offers insight into the mind of one of the greatest money managers of all times. Lynch helps you discover that he is a normal guy (like you and me) who thinks rationally, believes in doing his own independent research on companies, asks plenty of questions, and gets caught off guard by the market at times, just like anyone else. Anyone thinking about buying individual stocks must read this book before they ever make their first stock purchase. While there are numerous lessons that Lynch dispels through this book, here are my personal “Top 10? that really stand out. I have in fact benefited from incorporating each of these lessons in my personal investment philosophy.personal investment philosophy I hope these also add to your investment arsenal. So let’s start right here.
Peter Lynch’s 10 investing gems 1.Understand the nature of the companies you own and the specific reasons for holding the stock. A lot of people buy stocks with the mentality – “This stock is really going up!” This reasoning of buying stocks has never worked in the long run. You might buy a stock that is going up in price, and you might make some money in the short run. But in the long run, this basis of buying stocks is going to suck you into a never ending whirlpool of losses. A stock is just a share in a business. So it’s important to understand what is the kind of “business” that you are getting into. And then you must have specific reasons to buy and hold the stock (again, reasons that have less to do with how the stock price is doing and more to do with how the business is doing).
2. Consider the size of a company if you expect it to profit from a specific product. You might say, “I love Maggi! In fact, everyone loves Maggi. So Nestle must be a very good stock!” Let me ask you, “Great! But what if Maggi is just 1% of Nestle’s total sales, and the products that contribute the remaining 99% aren’t that great? Does Nestle still sound like a great investment just on the basis of one great product that contributes just 1% of its sales?” Now what do you say?
3. Be suspicious of companies with growth rates of 50-100% a year. “Growth for the sake of growth is the ideology of the cancer cell,” goes a famous saying. In the same way, companies that are growing at rates of 50-100% annually must be looked at with suspicion. One reason for this is that such growth cannot continue for long (for reasons like higher competition that might want to take a pie of this growth opportunity). The second reason is that if such a company still wants to push for higher growth for a few more years, it might have to infuse more capital in the business. This could either mean stretching the balance sheet (by taking on debt) or diluting equity (by issuing new shares). Both these are bad omens for existing shareholders. What is more, one year of slowdown in growth can come as a shock to the stock market, and might lead to a sharp fall in the stock price.
4. Distrust diversifications, which usually turn out to be diworsefications. Experience suggests that most diversifications (acquisitions of companies in the same area or a different one altogether) are done to satisfy the egos of promoters, and not for real business reasons. And most of the diversifications end up as diworseifications. So watch out for companies that are blazing guns in this space.
5. People get incredibly valuable fundamental information from their jobs that may not reach the professionals for months or even years. Not many small investors appreciate this, but it is one of the best ways they can pick great stocks. If I’m a banker, I know what makes up a bank’s balance sheet and I also know which banks are worth banking upon as investments. Considering this, I would be a fool eyeing biotechnology or IT stocks, especially when I don’t understand the ABCs of these industries, but just go by what my broker or friend advises me. Of course I might enhance my circle of competence and learn about these industries, but my first hunting ground must be ‘banking’.
6. Separate all stock tips from the tipper, even if the tipper is very smart, very rich and his or her last tip went up. Even if I love my fund manager for his stellar track record in managing my money, toeing all his stock ideas without doing my own research would be fraught with extreme risks. The stock he is recommending on CNBC might form just 0.001% of his total portfolio. I might be so enamored by his story on the stock, that I may buy it in bulk and it forms around 10% of my small portfolio. Now when this stock crashes, the fund manager would appear smart for taking a very small risk with it. I might lose my shirt. So the idea is to always do an independent research on a stock before you even think of buying it.
7. Invest in simple companies that appear dull, mundane, out of favour, and haven’t caught the street. Such a company is rarely covered by stock analysts and bought by fund managers. So there is a great chance that the stock could be available at a great bargain.
8. Companies that have no debt can’t go bankrupt. This is the most important lesson that you would remember (or forget) when it comes to identifying the right businesses for investment. Companies that borrow money to grow their businesses might appear good (because they are ‘growing’). But more often than not, such companies get so much intoxicated by the growth that they end up making a mess of their balance sheets, and in the process, destroying whatever shareholder wealth they created during “growth” years. Look at realty and construction companies, and you won’t have to look anywhere else for such examples.
9. Devote at least an hour a week to investment research. Adding up your dividends and figuring your gains and losses doesn’t count. I have been shouting this from the rooftop of Safal Niveshak all this time, but not many seem to hear. So now, let me tell you how much Peter Lynch believes in the power of “independent investment research” in the success of an investor. Lynch suggests that you must invest at least as much time and effort in choosing a new stock as you would in choosing a new refrigerator.
10. When in doubt, tune in later. Now this is where the emotional part about investing comes into play. I have spent ten days researching a stock, and thankfully on the eleventh day, I find that it’s a great business and even available at a good discount to the intrinsic value. So it seems like a perfect “buy”. Now, what in the world should stop me from buying this stock?
Well, here are some questions that must stop me from buying that stock (call it XYZ) instantly: Am I biased towards XYZ just because I’ve spent ten days researching it? Am I getting over-confident with my analysis? Am I impressed by just the company’s recent performance? Do I like the stock just because it has fallen in price? Do I like it just because my friend advised it to me in the first place? If the answer to any of these questions makes me uncomfortable, it’s an indication that I must sleep on the stock idea instead of buying the stock then.
There have been numerous instances where I have waited weeks or even months before committing money to a stock idea I liked. As Peter Lynch says, “The key organ for investing is the stomach, not the brain.” The 15-20 days after I complete my analysis on a stock help me know whether my stomach is ready to digest the stock even when the mind answers in the affirmative.
Chart In Focus, by Tom McClellan Deficits Are Good, Sort Of
A new Congress has been seated, and it brings the prospect of perhaps maybe potentially in a possible way doing something about the runaway federal deficits. And in other news, several New York area bridges are for sale, which you can acquire at a bargain price. Let us suppose, just for the sake of inquiry, that Congress ever actually did something to reduce the federal deficit, which would arguably be good for taxpayers (and for the grandchildren of taxpayers). The question is: would that be a good development for current investors? History says that no, it would be a bad development for investors. This week’s chart looks at the Annual Federal Deficit expressed as a percentage of GDP. The GDP numbers only go back to 1928, because it took until then for economists to invent the idea of GDP, which was previously described as GNP. But the idea of government spending more than is taken in goes back a lot furthereconomists to invent the idea of GDP
Over that time period, there have been 4 major instances of the annual deficit actually going negative (AKA a surplus), or in the case of the year 2000, to an almost negative state. In 1929 and 1930, when Herbert Hoover was president, the federal government confronted the prospect of another depression like that of 1919-20. Congress and the Hoover Administration responded in a similar way to what had worked before in that previous depression, by running a surplus just so that there would be reserves for the future. The only problem was that it did not work for Hoover, perhaps because the Federal Reserve actually raised interest rates in late 1929, trying to be helpful. This was the wrong medicine. In the early 1940s, the U.S. government ran up a huge debt to pay for the military buildup in WWII, and financed by War Bond drives. The result was a huge stimulus to the economy. But then leaders figured that after the war they ought to pay back that debt, and so the government ran surpluses in 1947 and 1948 (#2 in the chart). For the stock market, the result was a long drought that lasted until the federal government finally started running a small deficit again in 1949.
There was another small surplus in 1957-58, #3 in the chart. It did not seem to do much to the upward path of the DJIA, but it did indeed have a very real impact on the financial markets and the economy. For example, 25% of those known as “customers men”, now called stock brokers, were laid off. The DJIA may have continued higher into the 1960s, but the NYSE’s Advance-Decline line topped in 1956, and though that top was equaled in 1959, it did not exceed that level again until all the way into 2004. You may have heard that there was a federal budget surplus in the late 1990s, during President Clinton’s 2nd term, and that episode is highlighted as #4 in the chart above. Whether it was a surplus or not depends on which set of government statistics one chooses to believe. The Treasury Department’s Monthly Treasury Statement (MTS) showed numbers which assert that a surplus existed. But a separate part of the Treasury Department that is in charge of keeping track of the total federal debt shows that there was no actual shrinkage in the total debt from year to year. See this and this. So the supposed surplus was all accounting smoke and mirrors, since the total debt never actually went down. Monthly Treasury Statementthis
Still, just getting close to a surplus in 2000 was enough to kill the technology boom, and to usher in an economic recession that doomed President Clinton’s handpicked successor, VP Gore, to a defeat in the electoral college. At that time, the total federal debt was only $5.6 trillion, which in retrospect is such a cute little number. How times have changed. Now total debt is at $18.1 trillion.total debt is at $18.1 trillion Ever since 2001, the federal government has been running big fat deficits every year, and the stock market has partied on. Attempts to shrink the deficit in 2006-07 did help to usher in a stock market crash as the housing bubble collapsed, but since then there have been nothing but economically stimulative large annual deficits. And Congress does not seem to be in any urgent hurry to change that condition, even though such a change might actually save the country from a fiscal collapse. Congress has come to learn that it can count on a compliant Fed to bail us all out, so Congress does not seem eager to exert the type of real responsibility over the deficit which might injure our nice stock market uptrend
One other point history shows us is that if the federal government ever were to run a surplus again, it would be a big negative for gold prices. Here is a chart comparing gold to the MTS-quoted deficit as a percentage of GDP. You can see the supposed surplus in 1998-2001, which coincided with an historic low for gold prices. Over the past 4 years, deficits have been falling, and gold prices with them.
So if we were ever to get back to an actual budget surplus, the implication is that things would not go well for gold traders. All of these insights create a big conflict for investors. Do you wish to be a patriot, and not see your country reduced to a pile of ashes through excessive spending? Or do you wish to see your gold and stock holdings do well thanks to continued federal deficits? When contemplating this question, cognitive dissonance sets in, and it is hard to know what to think. But if one can be of two minds at the same time, then one can perhaps argue emphatically and patriotically for budget surpluses, so that our grandchildren do not have to be enslaved by our own debts, while at the same time preparing one’s investments for what is actually happening, the better to be prepared to help when things get even worse.