The Selling Climax-Responses
August 15, 2011
David R. Kotok
“You just slip out the back, Jack.
Make a new plan, Stan.
You don’t need to be coy, Roy.
Just get yourself free.
Hop on the bus, Gus.
You don’t need to discuss much.
Just drop off the key, Lee.
And get yourself free.” Paul Simon
On Saturday, August 13, we used our commentary to ask “Was There a Selling Climax?” See www.cumber.com. Readers’ responses were quite diverse. They demonstrate the range of outcomes under the present state of affairs. The range is 38,000 Dow high by 2025 to a “train wreck” as the low.
Paul wrote: “David, let me spin this from a bond investor perspective. Let’s put S&P earnings at $100 and let them grow at a 3% rate for 10 years. I get close to $140. Put an 8 multiple on that and get a price of 1120. So under pretty negative assumptions, the stock market should preserve your nominal capital over 10 years, while the dividend flow beats what a 10 year note will pay you in interest. So, I agree stocks are very cheap to bonds. But I am less confident they give me high returns. The profit share is high, and valuations are fair, not cheap. If the economy grows at a 3% or 4% rate, that is probably your expected return.”
Barry wrote: “David, your piece may have missed the very real possibility that our vibrant, innovative and productive economy of the past may be falling into a morass of rules, regulations, edicts, interference and overbearance by the government. Even if the current administration is replaced, it will be difficult and time consuming to put things right. I’m pessimistic.”
And Big Picture’s Barry noted: “S&P500 @2000 by 2020 is BEARISH, not bullish. That is a very modest set of gains over 9 years. Consider Jeff Hirsch’s book “Super Boom: Why the Dow Jones Will Hit 38,820 [by 2025] and How You Can Profit From It” (I wrote the forward for it). That’s a bit more bullish! I posted a chapter here — you should read this.”
Clarence wrote: “Any comparison of the 2010 waterfall decline and 1987 requires a more in-depth analysis. 1. The Dow was up >30% in ’87 before correcting, followed by black Monday. Such was not the case this year. 2. In 1987, did just about all the foreign markets have a 20%, 1 day decline? No. Was the Eurozone leading the decline? No. 3. No mention of the portfolio insurance/futures hedging debacle? In addition, the earnings yield, which for many years was a pretty good valuation indicator, has been on permanent vacation for several years. I would recommend looking at a chart comparing it to the S&P. I hope we don’t have a Eurozone-created “Lehman moment”.
Michael reminded: “There are technical guys out there showing downside risk in their reports. One or two of their key indicators is looking for another downward leg.”
Jim offered: “You give too much credit (or blame) to Greenspan. The US committed to upholding a certain range of values of the dollar in the Louvre Accord of February that year . The ranges were poorly chosen, which is why every stock market in the world ( except Hong Kong, which closed to avoid a crash) fell dramatically on Oct. 19, 1987.”
Jeff warned: “While I may agree with your prognostication of a 2000 SP500 index by 2020, I disagree on the current valuation of the market. Corporate margins are at historical highs, and ultimately will revert to their historical mean. Corporate aversion to hiring and capex spending help explain the high margins. This cycle will end. Consequently, forecasting continued growth from a level of $95 seems somewhat optimistic. Secular bear markets bottom when stock indexes are trading at 100% of book value, or single digit normalized price/earnings ratios. The current Shiller p/e [which normalizes reported earnings over the previous 10 years] suggests we have a long way to go before hitting the single-digit threshold. Before we get to 2000 in 8 years, which implies a total return of 9.0% per year including dividends, we will re-test the March 2009 lows. This market continues to be disconnected from the real world and, therefore, very treacherous. I am more of a like mind with John Hussman than with David Kotok regarding current market valuations.”
Linwood surmised: “ I would concur that your long-term assessment is correct about stocks. However, as a more short-term trader type, I would suggest that you consider a more defensive posture. We should know within days to weeks that the August 9 low will not be the long-term low, nor should it even be a short-term low in my estimation. Regardless, it doesn’t really matter if we drop another 10-40% in the equity markets if your timeframe is looking out 10 years from now, since everything should be fully recovered in a decade.”
And there was Don: “I would agree with you in a normal economic climate, but we are in abnormal economic state. The global situation is certainly not improving and I believe we will see much more continuation to the downside. As governments continue to kick the can down the road, I believe the results will be more than anyone could possibly visualize. There is no question a recession is a lock for 2012. There is no question fiat money is failing and will start defaulting as conditions worsen around the globe. The current markets react as if a pill or band-aid fixes the problem. Our government is in shambles, the President has lost credibility, offering nothing but blame and excuses, the repeated attempt to paint the picture pretty has backfired, policies are not in agreement with the people, and now the S&P is being attacked because they followed thru on the warnings given to the government for a considerable amount of time. You may consider me a bear, but I consider only reality. The reality of current conditions and the actions of governments tells me we are going to have a major train wreck, and what occurred the past week was only losing the caboose. This is a great trader’s market and not a good time for long term plays.”
Steve offered: “We are keeping two lists (confirming and disconfirming evidence for each) and checking them twice: 1. We are Japan, and don’t know it yet. Slow growth, miserable productivity, repressive government policies. We call this the 10-year-at-2.1%-is-right list. (I hear David Rosenberg is suggesting a 1.5% ten-year.) 2. Growth, modest in the West and strong in EM, so nominal is the US is 4-5% and real is 2.0%-3.0%. So far, the macro and industrial data and our unending conversations with portfolio managers in our underlying funds (our use of ETFs is small), has a very skinny list under #1 and very long and positive list under #2.”
And lastly from Denny: “You have earned a new nickname: “El Toro Loco”… Term of endearment of course! Laszlo Birinyi… Eat your heart out!! Time for a double Bloody Mary. Cheers.”
We thank these and the many other readers for their comments. Only time will tell if we saw a bottom at S&P 1100, on August 9 at 2:44 PM.
“You’ve got to cool water when the fever runs high.” Paul Simon.
David R. Kotok, Chairman and Chief Investment Officer