2005 is Not Like 1995 Market Views of Comstock Partners, Inc. Thursday, May 26, 2005
Some observers compare this year’s stock market to that of 1995, when stocks began to soar during an economic soft-landing following a period of tight money. They presume that as investors begin to see the last of the Fed’s rate increases, stocks will move significantly higher, much as they did a decade ago. In our view, however, the two periods are vastly different, both technically and fundamentally, while the similarities are somewhat superficial. We think it is much more probable that the current trading range, now over six months old, will be resolved by a significant and damaging decline.
Although it is entirely plausible that the series of rate increases is approaching an end, investors this time, never got anywhere near as pessimistic about the outlook as they did ten years ago. In late 1994 the Investor’s Intelligence Survey showed only 32% bullish and a relatively high 50% bearish, compared to the present 47% bullish and 26% bearish. In addition the cash-to-asset ratio in equity mutual funds was about 8% then, and only 4% now. When the market trades in a narrow range for lengthy periods the direction of the eventual breakout is highly likely to move opposite to the prevailing sentiment.
In terms of valuation the current market is substantially more expensive than in 1994. The S&P 500 is now selling at about 22 times trailing trendline earnings compared to 14 times ten years ago. From that point the market soared to 37 times trendline earnings in early 2000. That price-earnings ratio capped the bubble, and was 76% higher than the top of any market P/E for over 100 years. It is unlikely to happen again anytime soon. In 1994 we were in a secular bull market, and the top of the trading range was an all-time high. Today we are in a secular bear market with this year’s high a full 21% lower than the 2000 peak.
Fundamentally, there are other important differences between the two periods. In the 12 months ended April 30 the economy added 2.2 million jobs, compared to a much larger 3.9 million in 1994 on a far smaller base. In fact the increase a decade ago amounted to 3.4%, double the current rise of only 1.7%. In addition today’s economy is riddled with key structural imbalances that were simply not a factor in the prior period. The consumer savings rate is now down to a miniscule 0.4% as opposed to about 5.5% in 1994. The trade deficit is a huge 6.3% of GDP now and about 2% then. Household debt as a percent of GDP is currently 89, compared to 64 a decade earlier.
There is yet another item of great importance that should not be overlooked. In 1994 the introduction of the Netscape browser provided the first user-friendly graphics that made the Internet easily accessible to hundreds of millions of individuals and businesses around the globe. This set off the great technology boom that culminated in the bubble that came to an end in 2000. There is nothing anywhere near that magnitude on the horizon today, and the major structural imbalances left over from the bubble have yet to be corrected. In sum, we believe that the odds are high that the breakout from the present six-month trading range will be on the downside.
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