Then & Now

Over the past 3½ years markets crawled higher, we have
watched the gradual but steady build up of bullish expectations. You can see it
most plainly in the 2006 BusinessWeek forecasts. The majority of strategists,
technicians and economists are expecting gains for the markets in 2006, ranging
from mid-single digits up to as high as 30%.

In the Fall of 2002, you were hard pressed to find such
sentiment. As telecom stocks bottomed, and profitable technology stocks sold
for less than cash on hand, the Bulls were MIA. Telecom, tech and internet
stocks, having so duplicitously betrayed their lovers, were widely despised.

It wasn’t only the sentiment that was different back then:
Nearly every metric we track was in a different part of the cycle, and pointing
in a different direction. Both the vector and angular momentum were different
than at present. Consider each of the following:

Interest Rates: In 2002, bond yields were low and heading
lower. Since then, bonds have worked their way lower sending yields considerably
higher – and they’re heading even higher still; (See nearby Yield Curve charts);

Inflation: The Fed reflated the economy, but awoke
inflation. 3 years ago, prices were stable; the big fear was deflation. Today,
prices for goods and services are rising.

Earnings Growth: Year-over-Year earnings were awful in 2002, with easy comparisons, and
nowhere to go but up. Today, with comparisons much harder, earnings growth is a
the top of its range, and is more likely to decelerate;

Fiscal Policy: The Deficit was modest; Federal taxes,
especially those on dividends and capital gains, were being cut. Today, rates are more likely to rise than
drop. Taxes at the State and local level have been creeping higher;

Real Estate: was beginning a historic growth spurt with
major economic impacts: it created 42% of new private sector jobs, allowed
mortgage equity extraction of $2 trillion dollars, and drove massive consumer
spending – and GDP. Today, at best RE is cooling down; At worst . . .

Consumer Debt: was problematic, but manageable. Now, the
negative savings rate combined with significant increases in mortgage debt are
extremely concerning.

Commodities: Oil was
under $30 and exerted little drag on consumer spending or transport costs;
Industrial Metals were cheap, Gold and Silver were half their present

The macro environment, despite the negative sentiment – or more accurately, in large part, because of it – was far
more attractive three years ago than it is today.

Is this a case of the “Wall
of Worry”
or more like “What, Me Worry?”


Note:  This was part of a larger research piece that was emailed to institutional clients on April 11, 2006 at ~10:00am

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What's been said:

Discussions found on the web:
  1. todd commented on Apr 12

    interesting cover story in BusinessWeek… S&P 100 earnings up 213.4%; Share prices up 0.9%! They really don’t give a good explanation either, besides increased appetite for risk.

  2. B commented on Apr 12

    Anyone look at the corporate bond market? dum, dum, dedum.

    Ford cratered big yesterday. GM and Ford’s cumulative market value is, what, about 1/10th of Google? And their sales are, what, 100x Google? GM and F employ about 550,000 people. And the ancillary businesses globally that support GM & F employ are estimated to be 10 million people? That equates to direct line revenue of, what, a trillion or more dollars annually? GM and F’s total obligations are closing in on $1 trillion including pensions………

    The $25 trillion credit derivatives market is very vulnerable to a crisis if someone fails to pay on contracts that insure creditors from companies defaulting. GM and Ford are two of the top five companies most frequently included in credit-derivatives contracts GLOBALLY.

    One never knows where the crisis will occur. Three of the last market declines had nothing to do with a recession. 1987, 1998, 2000. This will likely be the same situation ………. with a twist. The MBS market, GM & F, global commodities bubble…that is beginning to look like a possible superspike that Goldman predicted across metals and crude. Rising rates that likely won’t abate till the CRB abates. What will it be? The perfect storm?

  3. Steve commented on Apr 12

    So..the end of good times is near?

    You recommend only 15% in US stocks for year end 2006 according to the BW predictions for the dow…any hints on where to put the other 85%?

    Also…any more Apprenticed Investor articles coming? As a young trader/investor, they’ve helped me a great deal in developing my strategies, so thanks for helping me see the ‘big picture’ (pun intended)

  4. Jim commented on Apr 12

    I love your Blog.

    I agree and as well am a realist, not so much a perma bear. Since we look at the past to give us some indication of the future lets take a look at past charts. Create a monthly candle sitck chart of the S&P 500 going back to 2000 to present. Notice anything? Notice from 2000 top to about mid 2003 the body of the sicks are very large. Notice from the mid 2003 up to present how small the sticks are? Interesting but to me it says something more is at play here and what ever it is is keeping this market very stable. So the next correction (if we get it) I am in all the way. Having said that, 30% of my equity portfolio will have a very short term strategy, very short!

  5. Jim commented on Apr 12

    One more thing, take a look at the GMAC bond 6.15% mat 4/5/2007. Bought some yesterday with a 8.5% yield to maturity. One year getting 8.5% with very little risk? Yeah me too, no brainer!!

  6. Bill Gross commented on Apr 12


    look at me…i’m bill gross…billionaire bond maestro.

    i like to write stuff on my web page…kinda like
    mr. smarty pants barry ritholtz…

    i should start a blog called the biggER picture and
    tell people i’m smarter and richer than barry…

    leap puts on indexes…

    bond man has spoken

    -bill gross

  7. bill grocer commented on Apr 12

    Gross is worth reading usually –like our host.
    It’s not a matter of having a web page and telling people you’re smarter.

    Those very people in need of being told who is smarter, are smarter than that and decide that issue for themselves (imagine!).[Talk about the lack of qualified personnel for the job. We need more dummies for this job. The world is just getting too competitive!]

    Poster bill gross could test this on his own web page: would/do people continue to read his/her commentary with/despite the offering/dictum that bill gross is uncontestably smarter and richer?

  8. Alaskan_Pete commented on Apr 12

    I think Doug Noland has it nailed down pretty well. The leveraged spec community has essentially co-opted the monetary creation system via the credit markets.

    If we back up and look at honest stats on the economy, particularly WRT the GDP deflator, you may find we’ve already entered a recession. What good is an 8% return on the SPX when real inflation is running 7%?

  9. Alaskan_Pete commented on Apr 12

    Gross’s writing always strikes me as muddled, a little underwhelming, and it doesn’t reflect his stature in the financial world.

    However, he runs big loot that moves markets, so you have to respect the opinion regardless of how you view the man.

  10. muckdog commented on Apr 12

    Isn’t Bill Gross that guy who predicted DOW 5000 a few years back? Just asking.

    I like field goal kickers who have a little accuracy. Just saying.

  11. thecynic commented on Apr 12

    DJIA 5k isn’t all that crazy if you put a bear market low multiple on Dow earnings.. take current earnings of $483 and grow it at GDP for a couple of years and put a 8x or 9x multiple on it and you can see where he got the 5000 number.. it’s not all that far fetched if we are indeed in a secular bear market that will bottom at 8x earnings like in previous bear markets…

  12. todd commented on Apr 12

    Multiple compression is the result, but it is not the answer!

    I do think the answer is mostly increased appetite for risk, though. Investors are putting their money to work in more traditionally risky areas… foreign markets, commodities and real estate. (Can you remember the days when investing in real estate was considered a risk?!?)

    At any sign of a U.S. recession though, all these areas are going to get HAMMERED! When the Street washes out the current group of suckers, it will be back to blue chips.

  13. B commented on Apr 12

    Was it you who was pondering assets and the Marshallian K on another post? Isn’t it generally accepted that the MK increases in times of uncertainty and decreases in times of certain economic growth. ie There is less incentive to hold money.

    A rising MK is also counter to a negative savings rate…sort of. Or could be interpreted as such with other supporting data. Of course, the negative savings rate will stay negative at some point as I think you and I have chatted about before. There are 14 million more retirees in the US than 20 years ago and twenty years from now that number will astronomical. As that will only increase, our savings rate, by definition of how it is calculated, will likely continue to decrease and remain negative over time.

    I believe the S&P at 800 is mighty close to FV here. Especially if bonds jolt to 6%, which my work says is a definite possibility. Now, things seldom get to a destination in a straight line as witnessed by the “wavy” nature of markets. And, by the time we meander near 800, FV might be significantly higher but…………..This time, post 1929 and post 1968, two strongly correlated environments of high productivity, strong dollar booms followed by weak dollar, inflationary, asset driven booms is very dangerous.

    Of course, if corporate profits continue to rise I guess the market and bond yields could rise in tandem. Similar to 1987. DOH!

  14. thecynic commented on Apr 12

    i understand marshallian k to be the growth rate of the money supply (i used M2) v the growth rate of GDP.. when the money supply grows faster than GDP like in the 2000-2003 example then their is excess liquidity for the economy to absorb (which probably found its way into asset prices). the yield curve widened 300bps during that period, i’m assuming to tighten while the Fed was easy.. and then the opposite, when GDP grows faster than the money supply then liquidity becomes tight or tighter.. this was the case since the high in 7/03 just after the Fed finished and the 2s/10s curve started to narrow..
    since the Fed started hiking rates, the yield curve was easing through a flatter spread and got inverted (signalling tight money) but marshallian k (another signal of tight money) didn’t follow as closely on the way down, signalling that there was still ample liquidity to go around.. i’m sure this is why gold and oil are still at highs despite 375 bps of tightening.
    now i think that if Fed doesn’t continue to hike past 5% and liquidity is still ample the bond market will look to tighten on its own through a wider yield curve.. this could easily take the 10YR note yield over 6% even as corporate profits slow.. which they will.
    who knows if i’m right, it’s a theory
    bottom line is Fed still has more work to do to curb inflation and if they don’t take care of biz, the bond market will take over and Bernanke will have no credibility.

  15. Tim commented on Apr 12

    Barry – just one comment regarding the Real Estate impact issue. The growth spurt was already long in the tooth circa 2002. By most metrics, the growth actually began as early as 1997.

  16. Mark commented on Apr 12


    Where does on put their money when they think FV for the market is 2/3 of where it is today? (“I believe the S&P at 800 is mighty close to FV here. “)

  17. thecynic commented on Apr 12

    B – how about this allocation?

    30% 3.5%+ dividend paying stocks, but not util, reits or auto, hopefully yield will provide a floor for the price and you get paid to own.
    15% russell 2k short fund
    15% gold
    40% cash

    my 2 cents

  18. B commented on Apr 12

    I think there’s also a cash component to mk

  19. B commented on Apr 12

    I could be wrong, but I think dividend paying stocks are likely one of the ones most likely to crater. Dividends are way out of wack with the historical average and are getting way out of wack with fixed alternative investments. Most have been cratering for months or more and are already down significantly.

    If rates don’t go up much more, we might see another 10% downside to dividend paying stocks, but if they do, I can see them taking a serious hit. Leaders never repeat in cycles and one of the leaders this cycle has been dividend paying stocks. It was easy to pick something with a 5-6% yield when short rates were 1% and long was 3%. Now at 5% and maybe 6%, they are very exposed. That premium implies they will produce above market returns in return for a paltry dividend in comparison to fixed investments. So, unless this asset class continues to outperform the market in profits, they are screwed.

    I think gold is a bubble but when it cracks, I don’t know. It’ll likely crack when the market cracks because this cycle is all about the asset boom. So, if one believes the market will correct, then I’d be out of gold. Plus the PE of gold stocks are 40-70x earnings even though gold has been elevated for some time. The only gold I would toy with is the ETF because of liquidity reasons. It’d be only a trade.

    R2K short, if and when the market falls, should pay handsomely. That index is overburdened with asset stocks.

    My 2c

  20. Alex Khenkin commented on Apr 12

    “Isn’t Bill Gross that guy who predicted DOW 5000 a few years back? Just asking.”
    He didn’t exactly “predict” it, but said it was the value from which investors might expect decent returns going forward. Not exactly a forecast. He did, however, predict 3% 10-year notes sometime last summer, along with Roach and some other “now-that-the-trend-is-well-under-way-I-make-a-forecast” crowd. You had to read it three times though to get what Gross was saying, as usual.
    Small Investor Chronicles

  21. thecynic commented on Apr 12

    in re to AA:
    i am not at all bullish but i feel dividends will perfrom better on relative basis.. it’s really value stocks (if you can find any) i like that pay a yield. if stocks puke, dividends should cushion the pain and you can reinvest at lower multiples.
    gold is a hedge v short russell 2k.. it’s the equity/gold ratio trade which despite the rally this year has made money – gold has out performed even the Russell. i agree gold is toppy and the fed is tightening which ultimately won’t be good for any commodity, but i could be wrong and if i am and stocks rally, gold should rally more. if gold falls, stocks will fall more.. at least that’s the idea
    plus gold is also a good hedge on the cash position.. if the gov continues to inflate and your real cash yield falls, gold should compensate for some of the difference

  22. thecynic commented on Apr 12

    also curious to what you mean by cash component in marshallian k.. i’d like to know if i’m missing something or if M2 is to what you are referring..

  23. hbt commented on Apr 12

    on interest rate changes of late…. though most the ADR’s/closed-end funds & ETF’s have held their ground of late- check-out the MSD (the Morgan Stanley Emerging Mkt Debt “etf”)… it is down 10 &1/2 % in the last two weeks on higher volume…

  24. wcw commented on Apr 12

    That’s because emerging markets spreads had shrunk to the point that you weren’t being compensated for taking them any more. You might as well sink your cash into treasuries and a buy some nondollar currency calls; you’ll end up with almost the same return profile, without any risk of spreads widening again a la MSD/TEI/etc.

    When volatilities are reasonable, as they are now, if you really want to protect on the downside, buy the cheapest puts you can get. It’s 1999 that’s tough, when you’re stuck with pumped vols and the impossibility of shorting fluff that doubles overnight.

    What I find difficult is making money on the upside in the interim. My 1999 numbers were just abysmal relative to the indexes, and I’ve always rued my inability to participate more during that blowoff.

  25. Mark commented on Apr 13


    It’s nice to have it all ways. Sure you may have missed some gains during a blowoff move but I take it you didn’t feel the pain on the long slide down. There are plenty of very, very smart people out there right now that are sitting around with loads of cash RIGHT NOW, and the markets aren’t bubbly by any means just overvalued.

    How’s this for AA:

    15% GLD
    10% Gold miners
    15% US Equities (underweight financials), hedged
    15% EWM and EWT
    10% IXC
    5% Canadian Oil sands
    30% ST Treasuries
    10% cash

    Comments welcome.

  26. Ned commented on Apr 13

    Big problem with the “dividend as cushion and paid to wait thesis” is that if stocks go down 20% that 3.5% dividend won’t protect you much. The price of the stock is more important and dividends do not ease the pain of bear markets. IMHO. Hold cash as it earns more than most dividends anyway and has no volatility.
    FWIW and my 2C.

  27. thecynic commented on Apr 13

    they can provide a cushion because the market will not allow the yield to get too high thus putting a floor on the price.. you guys are missing the point… if you are holding non-dividend stocks there is no floor. if the S&P is down 20%, dividend stocks might be down 15% and non-dividend stocks might be down 40%
    all i’m saying

  28. B commented on Apr 13

    I agree with nearly everything you say on here but……….I have to tell you I am very concerned because it is the dividend yielding stocks that are leading the market down and have been for some time. How far? Heck, this might be a minor correction but I doubt it because the ten year broke a big psychological barrier today and nearly every bond sub market is really acting extremely unhealthy here. In fact, I’m wondering if some type of stink is nearly upon us for them to reverse so quickly. In the futures market, many people are upside down on this trade by the hugest of margins. More fuel for a mess as they unwind.

    If rates stay relatively low, I agree with you. If they don’t……..And even if the long bond stays relatively well behaved longer term, during a market correction the ten year could have a blow off rate explosion just as stocks do. We’ve seen it before. If that happens, a correction will be magnified in financials and other dividend yielding stocks until the rate blowoff abates. (1987) Many financial sector stocks which are big dividend paying stocks, went through the entire 1970s with major corrections and never hit a new high till the 1980s. I am very fearful of dividend yielding stocks in a correction. Long term, they are proven time and again as being the best investment.

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