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hussman's latest.
June 1, 2004
Do Valuations "Feel" About Right?
John P. Hussman, Ph.D.
All rights reserved and actively enforced.
“This really blew my mind; the fact that me – an overfed, long-haired… leaping gnome – should be the star of a Hollywood movie. Hmmm. But, there I was.”
- Spill the Wine, Eric Burdon & War, 1970
The last time we saw a bad decade for stocks, I was growing up in Chicago, listening to “hippie” songs like that on the radio, and stocks were selling about the multiples they're selling at today (a bit lower then, but sometimes bad is bad). Well, thirty years later, some of those hippies have cut their hair and have taken their stations at major Wall Street firms. You can still identify them from the way they analyze the market by talking about what “feels” right. As in, “A P/E of 20 times operating earnings feels about right,” or “It feels like this economy is entering a real expansion phase.”
The problem with this sort of analysis-by-feeling is when those subjective feelings are simply contradicted by objective facts. It's like saying “It feels like this bond is going to deliver a 6% yield to maturity” when the bond is objectively priced to deliver 4%. The same is true of stocks. If you pay 18 times peak operating earnings at a time when there is an unusually wide gap between operating earnings and free cash flow, and when the historical norm has been closer to 12 times operating earnings, you can say all you want about valuations “feeling right.” The fact is that you're going to earn unusually low long-term returns.
So the argument gets bolstered by the claim that inflation and interest rates are low, so P/E multiples ought to be higher. But if you're going to compare the rate of return on stocks to the rates of return on other assets, you'd better be talking about securities of similar duration. As I've noted before, the duration of stocks is over 60 years here (at normal historical valuations, the duration has been closer to 25 years). The duration of a 10-year bond is about 8 years. Unless the argument is that interest rates and inflation are likely to remain low for the indefinite future, it's absurd to argue that present levels of inflation and interest rates are relevant to setting the valuations of stocks.
Not that inflation is even low anymore, if anyone would bother to check. The year-over-year rate for the CPI has now climbed to 2.3%, with a year-over-year rate of 3.7% for the PPI. With little doubt, the upcoming comparisons will be even higher, given that recent energy price increases will largely hit the May numbers when they are released later this month. Then add this fact: increases in short-term interest rates have a strong tendency to increase monetary velocity, accelerating the inflationary effects of the prior monetary ease. That's analytical shorthand for saying that inflation surprises are likely to be firmly to the upside in the months ahead.
As I noted last week, output growth has a tendency to reduce, not increase the rate of inflation. In fact, periods of higher output growth are consistently associated with lower rates of inflation (simply, prices are a reflection of scarcity – greater output supply implies less price pressure). So without the fairly rapid growth we've seen in GDP over the past few quarters, inflation rates would have been even higher. The difficulty here is that the underlying measures of capital and labor demand – capacity utilization, help wanted, bank lending, commercial paper issuance – are all still very tepid for this point in an expansion. (With regard to the help wanted index, online advertising may have some effect on the level of the index, but it should still be trending higher, which it is not).
While I don't place too much emphasis on econometric models or forecasts, it's of at least some concern that our inflation models are now more hostile than they've been at any time since the 1970's.
So on the inflation front, it seems about time to pull out the bell bottoms, tie-dye shirts and vinyl 45's… maybe go for some Deep Purple, Grand Funk Railroad, Bachman Turner Overdrive and The Guess Who.
Groovy.
Market Climate
The Market Climate for stocks remains characterized by unusually unfavorable valuations and unfavorable market action. The Strategic Growth Fund remains fully invested in a broadly diversified portfolio of stocks, with an offsetting hedge intended to remove the impact of overall market fluctuations from that portfolio.
After the deeply oversold status that the market achieved a few weeks ago, we've seen the standard “fast, furious, and prone to failure” rally to clear that. It's important to emphasize how dangerous it is to attempt “playing” these rallies. In a negative Climate like this, stocks can remain deeply oversold for some time, so oversold conditions in and of themselves make poor buy points. Similarly, the subsequent rallies tend to end without notice, and often without hitting “standard” resistance points such as moving averages, Bollinger bands, or prior resistance levels. It's possible, when interest rates are falling, to construct certain favorable “sub-Climates” within what would commonly be viewed as bear markets. But in decades of research, I've still not found a reliable means to capture brief “bear market rallies” that don't include falling yields as a requirement. We don't have that here, so all rallies in this Climate should be viewed as suspect.
In bonds, the recent rally in straight bonds provides a reasonable opportunity to reduce portfolio duration. In the Strategic Total Return Fund, our present duration of about 3.5 years is solidly in Treasury Inflation Protected Securities, which I continue to view as useful investments here. The Market Climate for precious metals also remains favorable, while the U.S. dollar continues to appear vulnerable. The markets continued to re-evaluate the risks of inflation last week (correctly, in my view), so we've seen a nice recovery in many inflation-linked assets. Overall, the Strategic Total Return Fund remains positioned primarily to benefit from downward pressure on real interest rates and the U.S. dollar, but our overall exposure to risk is relatively conservative in all of the asset classes we hold – TIPS, precious metals, utilities, U.S. agency notes, and foreign government securities.
I don't know if it is important since this failure was accompanied by renewed put buying, every single little puny wiggle down is taken as a signal that the rally is over, that indicates too many people are bearish.
but how normal is it that we have these low volume markets where they feel a need to jam the tick up to 1000-1400 several times a day, for weeks at a time?
well, its anecdotal and colored by some other factors. see below:
"After 23 years of falling interest rates, the U.S. is at a turning point. When it comes to easy money, the party's over. But we should be fine." Fortune, May 17, 2004
"This time, Fed tightening shouldn't make you tense." Business Week, May 24, 2004
"Yes, prices are rising, but not to worry." Business Week, May 31, 2004
"Why a dose of inflation is good for you." Time, May 24, 2004
"I don't see a problem with mortgage rates unless they go above 8% and I don't know anyone who has a forecast that outrageous." Jim Smith, chief economist of Industrial & Office Realtors, as quoted in BusinessWeek Online, May 20, 2004
"The optimist proclaims that we live in the best of all possible worlds; and the pessimist fears this is true." James Branch Cabell (1879-1958), The Silver Stallion, 1926
At Schaeffer's Investment Research, we refer to the "feeling tone" regarding the market and the economy as expressed in the financial media as "anecdotal sentiment." And as I write this commentary, anecdotal sentiment (a sampling of which is listed above) can only be described as "over-the-top bullish." So extreme is this optimism that it eagerly incorporates such legitimate concerns as rising interest rates and accelerating inflation and slowing economic growth and $40 oil into a mosaic whose theme is "It's all good!" If you understand that over-the-top bullishness on the part of Wall Street opinion leaders as expressed in the mass media has very worrisome implications for the stock market, then you have my permission to be very worried.
But "anecdotal sentiment" can encompass more than the mood reflected in media headlines. For example, it has been reported over the past several months that two of the most successful electronic exchanges are moving toward going public. The last instance of buzz about stock exchanges planning IPOs was in the months ahead of the peak of the 1990s bubble.
And if you recall the period ahead of the 1987 market crash, you are familiar with the near-mania for selling puts on the stock indices that, needless to say, ended in disaster. So it is less than reassuring these days when (as reported in the 5/24/04 issue of Barron's) "more strategists and brokers have begun reminding investors to consider selling options."
Moving from the anecdotal world to the quantified world of volatility indices offers little solace. I prefer to use overbought/ oversold indicators when gauging long-term extremes in the volatility indices. Such an approach avoids the issue of differing "normal" levels of volatility at various points in time and instead focuses on extreme movements in volatility regardless of level.
When the volatility indices are oversold, it means they have been aggressively declining for an extended time period. By implication this means that investors have become very comfortable with selling option premium, in large part because they see little probability of a major market decline. Unfortunately, it is during such periods that the market becomes most vulnerable to downside shocks. So it was not at all comforting when I recently determined that in February 2004 the CBOE volatility indices (VIX and VXO) reached their most oversold extremes for the past 20 years - more oversold than the period ahead of the 1987 crash and more oversold than the period ahead of the bubble peak in 2000.
A market that is highly vulnerable to a major decline is by no means a market that must crash tomorrow. In fact, such a market is likely to have built up a good deal of upside momentum in an environment where the news backdrop is good (or is interpreted as good). As such, new money continues to flow into the market and even investors with concerns and misgivings are reluctant to leave the party too soon. As Yogi Berra was purported to have said: "It ain't over till it's over." Until it's over, I will continue to look for pockets of opportunity on the long side while playing the big blue chips on the short side. But when it's over, it is likely to be so ugly that it will be a long, long time before investors dare to fall in love with stocks again.
"If it was not for the excessive put buying"
although, as in the note from shaeffer that i posted earlier, a chunk of that put activity could have been selling. (he seems to think its a significant amount of the activity seen now.)
"a slow-moving line for charge sales"
hehe. but i think that's just all the canter's employees have that 'east-coast deli waitress attitude'.
awww. u always say that.
um, can i go to the boys room?
bernie shaeffer's contrarian views:
summary:
- anecdotal sentiment is "over-the-top bullish"
- high put activity might be selling of puts: '(as reported in the 5/24/04 issue of Barron's) "more strategists and brokers have begun reminding investors to consider selling options."'
- in February 2004 the CBOE volatility indices (VIX and VXO) reached their most oversold extremes for the past 20 years - more oversold than the period ahead of the 1987 crash and more oversold than the period ahead of the bubble peak in 2000.
June Option Advisor Commentary: It's All Good?
Bernie Schaeffer
6/3/2004 7:30 AM ET
The following is a reprint of Bernie Schaeffer's market commentary from the June edition of the Option Advisor, published on May 27. Prices and the chart are as of the close on May 27. For more information or to subscribe to the Option Advisor, click here.
"After 23 years of falling interest rates, the U.S. is at a turning point. When it comes to easy money, the party's over. But we should be fine." Fortune, May 17, 2004
"This time, Fed tightening shouldn't make you tense." Business Week, May 24, 2004
"Yes, prices are rising, but not to worry." Business Week, May 31, 2004
"Why a dose of inflation is good for you." Time, May 24, 2004
"I don't see a problem with mortgage rates unless they go above 8% and I don't know anyone who has a forecast that outrageous." Jim Smith, chief economist of Industrial & Office Realtors, as quoted in BusinessWeek Online, May 20, 2004
"The optimist proclaims that we live in the best of all possible worlds; and the pessimist fears this is true." James Branch Cabell (1879-1958), The Silver Stallion, 1926
At Schaeffer's Investment Research, we refer to the "feeling tone" regarding the market and the economy as expressed in the financial media as "anecdotal sentiment." And as I write this commentary, anecdotal sentiment (a sampling of which is listed above) can only be described as "over-the-top bullish." So extreme is this optimism that it eagerly incorporates such legitimate concerns as rising interest rates and accelerating inflation and slowing economic growth and $40 oil into a mosaic whose theme is "It's all good!" If you understand that over-the-top bullishness on the part of Wall Street opinion leaders as expressed in the mass media has very worrisome implications for the stock market, then you have my permission to be very worried.
But "anecdotal sentiment" can encompass more than the mood reflected in media headlines. For example, it has been reported over the past several months that two of the most successful electronic exchanges are moving toward going public. The last instance of buzz about stock exchanges planning IPOs was in the months ahead of the peak of the 1990s bubble.
And if you recall the period ahead of the 1987 market crash, you are familiar with the near-mania for selling puts on the stock indices that, needless to say, ended in disaster. So it is less than reassuring these days when (as reported in the 5/24/04 issue of Barron's) "more strategists and brokers have begun reminding investors to consider selling options."
Moving from the anecdotal world to the quantified world of volatility indices offers little solace. I prefer to use overbought/ oversold indicators when gauging long-term extremes in the volatility indices. Such an approach avoids the issue of differing "normal" levels of volatility at various points in time and instead focuses on extreme movements in volatility regardless of level.
When the volatility indices are oversold, it means they have been aggressively declining for an extended time period. By implication this means that investors have become very comfortable with selling option premium, in large part because they see little probability of a major market decline. Unfortunately, it is during such periods that the market becomes most vulnerable to downside shocks. So it was not at all comforting when I recently determined that in February 2004 the CBOE volatility indices (VIX and VXO) reached their most oversold extremes for the past 20 years - more oversold than the period ahead of the 1987 crash and more oversold than the period ahead of the bubble peak in 2000.
A market that is highly vulnerable to a major decline is by no means a market that must crash tomorrow. In fact, such a market is likely to have built up a good deal of upside momentum in an environment where the news backdrop is good (or is interpreted as good). As such, new money continues to flow into the market and even investors with concerns and misgivings are reluctant to leave the party too soon. As Yogi Berra was purported to have said: "It ain't over till it's over." Until it's over, I will continue to look for pockets of opportunity on the long side while playing the big blue chips on the short side. But when it's over, it is likely to be so ugly that it will be a long, long time before investors dare to fall in love with stocks again.
"and i hope it will stay a volatile stock in the future althogh there has been some volume decrease since april,but still better than SNDK/QLGC and some others when volatility is concerned."
indeed. looks like the new range here is 12.50 to 14, which hasn't even made a dent on the overhead supply up to 25. barring one of those 'one day miracles', i think it'll be a long hard slog up, if that's where it goes. though i'd suspect down; still overvalued with respect to vtss, amcc ...
anybody concerned here that nazdog volume is a big yawn ... looks like ~1.3B today, unless things pick up ...
"... chinese Net related stocks and PMCS is a supplier to some of them"
well i'm not JO but i've followed pmcs for years: they're a supplier to csco; they also have their own commodity mips processor that they sell to the likes of printer manufacturers. all in all, its a dog with wings.
what they heck do they have to do with chinese internets? or do you mean the chinese csco cloner that's now hooked up with ... mmmm ... novell is it?
interesting correlations between high pmi's and market behavior:
http://www.chartoftheday.com/20040602.htm
no one else thinks its a "problem" when the homeland secutrity director endorses a company?
that would be cool. think of all the 'product placement' opportunites that there are in, say, state of the union addresses, meetings with heads of state, yadda yadda, that could help offset our national debt.
Here is something I found interesting in the paper today. The timing seems odd to me.
well of course there's that rumor floating around about it having to do with the close passage of that large asteroid at the end of this month ...
jcp double top? retailers should be a short in and around here, yes?
"lets see a monarchy that can go into any house without a warrant and cut off the heads of the owners without trial and your worried about their ability to handle terrorists..."
not fair. we're a democracy where they can wiretap and arrest at will and lock folks away forever without a trial or judge or attorney, and we still have trouble with terrorists ...
"if instead of counting the number of consecutive up days, we compared percentage gain over eight days? Any idea?"
no comparision at all ... e.g. remember greenspan's first surprise rate cut, jan 01? 14.17% in one day.
okay, okay, i'm lazy. but i like your picks: they're all on my watchlist and are things i've owned before. although i wouldn't expect any of them to go as low as the 200wma.
opec is already producing above their stated limits, and the only additional capacity that matters is in SA, since there ain't no more ... or so the newspapers tell me ...
"Now favor me your best guesstimate of where the following 12 stocks will be priced when the confluence of events mentioned above occurs?"
sigh. okay, completing the scenario, let's guesstimate that -- since a retreat on XAU to ~65 (and then reverse up) would be a penetration of the 200-wma (simple 200 week moving average), that we'd see similar pullbacks on all of those stocks, back to the 200wma.
some are bouncing around there right now, e.g. aem, gpxm, mng, cusif, kgc, drooy, gbn, rgld,
sigh, do i have to do everything?? okay, okay. lets say hui a shade under 150, say 145. i don't have long term charts for usd and gold right here, so let's move from hypothetical to wag (wild ass guess) and say usd = 96 and pog = 365
hi dan. so let me ask something hypothetically: lets say that those 3 black crows on the april weekly of the xau play out and we get to 65ish this summer. what would be your top 3 picks to buy at "bargain prices", for longerterm appreciation?
daily xau (from marketswing)
http://www.marketswing.com/forum/attachment.php?attachmentid=2905
re Google time: sometime late this summer, i believe.
"How Overbought is RHAT? OS Pumping, Lots of PR, No Profit"
note, though, they just resold a whole bag of convertible debt ...
"Why is YHOO jammin?"
gotta tag 60 by google time!
looks like it. odd, i have my charts set for 200-dema, which is ~27.50
"In fact INTC buying/covering since Apr 30th has been so steady,that we never actually got a clean bottom"
not a whole lot of covering, since the short ratio has been ~0.8 days for months ...
re program trading
wasn't there just a ruling letting mufu's hold more of etf's? if so, couldn't a big chunk of program trading be everyone just buying qqq's and spy's and leaving the arbitrage to programs?
Funny, in the last year, Gold and the market are almost in complete "lockstep", unusual. I was "conditioned" to use gold in lieu of shorting, but recently, that simply has not worked.
well that seems to go hand-in-hand with liquidity: liquidity injections -> falling dollar -> rally ...
well dan, no i didn't. i did profit off the very early part of this move, but sold too early. oh well. if i see some confirmation that the dollar is really heading down and the market up, i'll probably jump on for a little run. but the outlook everywhere, to me, is clear as mud.
"and these are not only musically aesthetic but structurally sublime."
so too with the schoenberg school ... although not so sure about "aesthetically sublime"
but what's better than act II scene 1 of wozzeck, where wozzeck and his doctor are talking/singing about a diet of beans as a very complex fugue.
well, that was before berg's 12-tone-itis ....
"Fidelity manager: I made mistakes
Magellan fund manager Robert Stansky says he misjudged the strength of the economic recovery."
odd. i just read an interview with him this morning which quoted him more extensively, and that clearly wasn't what he said, i.e. that he "misjudged the strength of the recovery". what he said was that he didn't believe folks would rush back into tech after the drubbing those stocks took. and that, together with the strength of small/midcaps last year, which has a negligible effect on a fund like magellan at its current size, led to underperformance.
"From the truly unexplainable:INTC TWICE this week dumped and painted a close about .20 lower than reality.Today I have INTC close at 28.55 when clearly it's in the 28.70s.And this also happened Tuesday when INTC painted 28.10 close when clearly it was in the 28.30s.What gives?"
schaeffer had a very negative overview on intc again yesterday - wrt put/call activity, low short interest, etc. and if i'm to infer anything from what i see on the island book (grain of salt), the sellers are a mile thick. my guess would be: its the index guys who are pushing it up, or tweaking the close, but who knows.
OT wild storm blowing thru central nj, watermelon sized hail....
seriously? that sounds almost biblical .... especially with the plague of locusts at full roar ...
what the heck is up with sbux?? honorary entry into the SOX?
scary ... although i guess its fit well with what i've observed. although more at a subconscious level, i suppose, cuz for the last few months, the only plays that have really made sense to me are index funds (short) or sector funds (long).
Dated? I drove one in the 70's!
whoa! mine never lets me do that in public ...
"btw,NVLS just said something judging from the ahs action."
hmm. well after a week of rallying, it seems only right that friday before a holiday should bring profit taking. so anything could be an excuse for a nice gap and crap and close flat tomorrow ... surprising that nvls could be a market mover, but with volumes so low, anything could be i guess ...
P.S. My guess is gold gets hammered.
i hope
candlewise, those 3 black crows on the weekly chart, starting 4/16, look scary, and the 50% retrace of that starting 5/14 is pretty much "textbook". on the other hand, the last three weeks do kinda look like three white soldiers. but its end of month ...