A High-Risk Market
Market Views of Comstock Partners, Inc.
Thursday, July 28, 2005
As in early 2000, the market is once again entering dangerous territory as investors remain oblivious to the increasing risks. Cash as a percentage of assets in equity mutual funds is down to 3.8%, the lowest level in 40 years while the VIX (CBOE Volatility Index) is at 10.5, its lowest in a decade. According to Investors’ Intelligence 56% of newsletter advisors are bullish and only 22% bearish. In addition the S&P 500 is selling at a historically high 20 times earnings and the dividend yield is a mere 1.7%. Once again we hear strategists and analysts calling this a “goldilocks” economy, not too hot and not too cold. The problem is we’ve heard this one before—in March 2000, we believe, just before a 78% plunge in Nasdaq and 51% in the S&P 500. The fact that the “goldilocks” word is being trotted out again should be taken as a dire warning rather than a reason to be overly complacent.
All of this is happening in the face of increasing risks. The Fed has tightened nine consecutive times, and they indicate no end in sight. The record of periods of monetary restraint gives us little confidence that the central bank knows when to stop until it’s too late to prevent a sharp slowdown or, more likely, a recession. Furthermore we are faced with high oil prices, a narrowing yield curve, flattening money supply and global dependence on a U.S. consumer using highly inflated housing prices to sustain a standard of living that is unsupported by real wage and salary growth.. The result is record low savings rates, record household debt, a huge trade balance and dependence on foreign nations to funnel enough dollars back into the U.S. to keep long-rates low.
The recent great success of domestic auto companies in selling huge numbers of vehicles through drastic discounting may be the last weapon left in the arsenal to keep the economy going for just a bit longer, but after that the cupboard is bare. GM has already said that the discounting is about to end. With no more tax cuts and Fed tightening, only housing is keeping the economy going, and when that plays out the game is over. With the temporary surge in vehicle sales, we wouldn’t even be surprised to see the savings rate drop to negative territory, an event that would be highly negative for continued consumer spending growth.
Although the S&P 500 has made a series of new four-year highs, the move has been more of a struggle than a real breakout. Following a previous 2005 intra-day high of 1229 on March 7, the index in July made successive highs at 1233, 1236, 1238 and 1245, and now stands only 1.1% above where it was over three months ago. Also note that the all-time high was at 1553 in March 2000, and we are still 20% below that level over five years later. That is why we believe this is still a secular bear market with major unfinished business on the downside.
© 2005 Comstock Partners, Inc.
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