Juggling Dynamite

Like it or not, believe or not, accept it or not, extreme asset valuations today mean that we are still mired in the secular bear (of high capital risk, low yields and poor future return prospects) that began in 2000.

To illuminate this point, Crestmont Research has updated its secular bull and bear market cycles charts on their website here.  As shown below, as in past secular bear periods,  the only thing that can finally end the one we are stuck in, and restore longer term return prospects to the risk-worth-taking zone, are much lower valuations including PE ratios 10 and under (green band below), versus 30+ today.  Until this mean reversion happens, present stock holders are just whistling past graveyards hoping for skill-less, blind luck to continue indefinitely.

However, the upside too rarely mentioned today, is that 18 years into this secular bear, we must be close to the end–the final mean reversion cycle that will finally restore attractive risk-return opportunities for our long-term savings once more.

For some important insight on this point, see Millennials, born under the sign of the bull, should embrace the bear:

The baby boomers entered the workforce from roughly 1966 to 1984. They couldn’t have timed it better because U.S. stocks were in an epic funk during those 19 years. The S&P 500 Index gained just 3.2 percent annually while inflation grew by 6.5 percent, which means the real value of U.S. stocks declined by a stunning 3.3 percent a year for nearly two decades…It also meant that by the time boomers entered their peak earnings years in the mid-1980s, the stage was set for the biggest market run-up on record…Millennials will soon enter their peak earnings years. They should root for recent market turmoil to turn into a long rout. And if their wish is granted, they should shovel as much money as possible into the market.

Note to boomers: we too can set ourselves up to take advantage of the next secular bull that will bring higher yields and help support us through our retirement years.  But first, we have to step off the long-always bus most are currently sleeping on, build up cash savings, and patiently wait for the low prices and valuations coming out of the next bear market.  Remember there can be no meaningful buying opportunity, unless we acted on a selling opportunity before it.

The bias of the financial sector is inherent:  Central banks, like most financial advisors, portfolio managers and media commentators, base most of their assessments on sell side research from investment banks.  This is financially destructive because as DiMartino explains below, the self-enriching sell side agenda is to“make sure that all of your clients are always 100% long”.  With a new chair heading the Fed this month, some say the central bank put backstopping financial markets is no longer assured.

The recent gut-wrenching drop in asset prices began on the first day of the job for new Federal Reserve Chairman Jerome Powell. How is Mr. Powell likely to react to a suddenly sick-looking market? Will he step in forcefully to reassure investors that there’s a “Powell put” in place as a backstop?

…Powell appears to be no large fan of continued quantitative easing, and has long been on the record as concerned about the eventual pain its unwind will cause. He very well may resist riding to the market’s rescue at this time, allowing natural market forces to finally have their way.   Here is a direct audio link.

Personally, I doubt that any central bank head will have the personal fortitude to withstand hysterical demands for ‘intervention’ when markets correct sharply. But the call for central banks to do something, anything! happens every downturn, and still vicious bear markets have been a recurring part of each cycle.  At some point misplaced confidence always fails, and repricing ensues, Fed notwithstanding.

Everyone wants to know what happened this week. Why is the stock market suddenly dropping like a stone? Is it machines selling?  Is it traders covering margin calls? Is it short volatility funds going under? Is it higher interest rates?  Is it Bitcoin crashing? The answer is yes, all of that.

But most of all, stocks are having their worst week in 9 years, because they have been hyped so irrationally high for so long now.  Truly, these markets have not been about investing for at least 5 years.

The same speculative, artificial and illegal interventions that worked to push valuations and risk-taking to the highest levels in history by January 2018, are now turning the other way.  It’s called mean reversion.  And as we’ve said many times, the aggressive risk-seeking behavior that increasingly drove indiscriminate buyers into dividend paying securities, funds and ETFs the past few years, is also hitting payback once more.

No, over-valued equities are not ‘defensive’, they’re capital destructive, as cyclical price declines routinely take back years worth of income in days and weeks.  The chart beside showing the declines in dividend focused sectors and funds over the past week, underlines the point.  (See:  Boring is no longer beautiful in stocks).

As we wrote in our January 31 client letter before this week’s sell-off, and demonstrated in the chart of the S&P 500 relative strength indicator since 1998 below:

“Indiscriminate buying has infected all sectors. This chart of the broad-based S&P 500 stock index—widely and thoughtlessly benchmarked by funds, pensions and conventional managers—confirms extreme capital risk warnings with a monthly RSI (‘relative strength indicator’ of price and time) today at an unprecedented 93, also far past the manic tops of both 2000 and 2007, when mean reversion next followed.”

We also showed the chart of Canada’s TSX stock index and noted that it would take a decline of just 5% to take Canada’s stock market back to the price level it first reached nearly a decade ago in June 2008. That has now been accomplished in one week.

From here, it will take just a mild bear market decline of 23% to return the Canadian stock market to where it was at the cycle top in September 2000- over 17 years ago. There is every reason to suspect that this will happen, it’s only a question of how quickly.

We say this not because we are clairvoyant; but because markets mean revert.  And when they have been mindlessly over-valued and over-bought for so long, equal and opposite in the other direction is due.