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ETFguide.com
Sucker Rally or New Bull Market - A Historical Perspective
Friday September 18, 1:07 pm ET
By Simon Maierhofer
Imagine the following: Your brand new car has a rattle. Responding to your request to fix the rattle, your dealer apologizes for the inconveniences, but tells you that new car rattles are quite common. In fact, rattles are the 'new normal' he says, you'd better get used to it.
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You paid good money for a car nobody else wanted to buy a while ago, so obviously you wouldn't accept this line of reasoning, right?
In a different scenario, but essentially the same situation, investors continue to gobble up stocks - which by historical measures are still overpriced (more about that later). Based on rising prices it is obvious that investors have accepted the fact that basic fundamentals aren't validating asking prices, with the simple explanation: It's the new normal, get used to it.
Before getting used to the new normal, it makes sense to figure out what the old normal was. Only if you know what historically normal conditions were, can you determine the extent to which the current situation deviates from what the market deems normal. This simple exercise may prevent you from making an expensive mistake.
What is normal?
The market's performance over the past 15 years has been much like a roller coaster. The amazing bull market of the 90s, crowned by the technology (NYSEArca: XLK - News) boom, came to an abrupt halt in the year 2000, which marked the beginning of an 80% decline for the Nasdaq (Nasdaq: ^IXIC).
Next was the bust of the real estate bubble in 2005. Housing prices dropped some 30%. Real estate ETFs such as the iShares Cohen & Steers Trust (NYSEArca: ICF - News), Vanguard REIT ETF (NYSEArca: VNQ - News), and SPDR Dow Jones REIT ETF (NYSEArca: RWR - News) reflected this decline and investors' pain.
2007 brought the end of the financial boom. Banks (NYSEArca: KBE - News) and other financial institutions (NYSEArca: XLF - News) dropped some 80% before catching their breath. This resulted in 50% losses for major indexes such as the S&P 500 (SNP: ^GSPC), Dow Jones (DJI: ^DJI) and Nasdaq (Nasdaq: QQQQ - News). International (NYSEArca: EFA - News) and emerging markets (NYSEArca: EEM - News) were not spared declines; in fact, they got hit harder.
Finally, in 2008, commodities tumbled. Oil led the way and other commodities followed. Gold (NYSEArca: GLD - News) has been the only market spared by a major decline, thus far...
In short, the past 15 years do not provide a clear picture of historic 'normal.' We have to look back further. But that's all right; we all know that those who don't learn from history are doomed to repeat it. The lessons to be learned are well worth the time spent.
General Electric - a miniature version of the U.S. economy
Since the Great Depression, there were two major phases of expansion. Phase I lasted from 1942 to 1966. Phase two stretched from 1975 to 2000. We saw periods of consolidation from 1967 to 1974 and from 2000 to today.
Productivity is the engine of all economies' growth. A steady measure of a country's productivity is the gross domestic product (GDP). The GDP measures a country's economic performance as it reflects the market value of all final goods and services produced within its borders, in a year.
A look at the GDP numbers reveals that the 1940s to mid-1960s marked the peak of U.S. productivity. General Electric provides valuable insight into what has happened since.
With its roots going back to 1890, when Thomas Edison first brought together several of his business interests; GE has seen and adapted to many economic changes. That's probably why GE is the only original company listed on the Dow in 1896, that remains until today.
Up to the late 1960s, GE was known for manufacturing quality products. 'We bring good things to life' was GE's slogan. In fact, the headquarters for GE's lighting division became the world's first industrial park (Nela Park). Its long history of producing power turbines, along with the resulting engineering know-how, opened the door to produce jet engines and aircraft superchargers. GE Aviation emerged as one of the world's largest engine manufacturers.
Throughout the 1960s, GE was one of the eight major computer companies, called 'Snow White' followed by the 'Seven Dwarfs' (IBM, NCR, Honeywell, RCA, UNIVAC, CDC, Burroughs).
The curious case of declining productivity
A major shift happened in the late 70s and 80s. GE ventured into television and high finance. GE Capital, GE Commercial Finance, GE Money, GE Consumer Finance, NBC Universal, etc. provided a different revenue stream than selling turbines, engines, refrigerators or lamps.
Products were not manufactured anymore, products were engineered. Profits were not based on the sale of tangible goods anymore; they were engineered by capitalizing on excess liquidity, interest spreads and risky financial maneuvers. If GE couldn't make money selling their products, they'd make money by financing consumer's purchases of their competitor's products. Aptly, GE's new slogan is 'Imagination at work.'
A look at the chart below shows that GDP has been steadily declining for many decades. The average annual GDP for the 25-year period starting in 1975 is nearly 1% lower than from 1942 - 1966. The average annual GDP from 2001 - 2008 is 2.23% lower than the normal levels seen from 1942 - 1966. Real GDP for the first quarter of 2009 decreased by 6.4%.
GDP might be the biggest, but certainly not the only concern. A comparison of phase I (1942 - 1966) with phase II (1975 - 2000) shows that factory's capacity utilization and household liquid assets have gone down, while federal debt, consumer debt, and unemployment numbers have gone up.
From 2000 to 2008 these spreads widened even further. 2009 saw the economy at a standstill. Corporate profits fell, consumer spending slid, and the stock market melted away.
Stocks on adrenaline
The slow but persistent deterioration of productivity, the engine of any economy, is rarely addressed by the financial media. Most investors want instant gratification, that's why the general focus is shortsighted. The stock market, however, has a memory like an elephant and knows when current activity doesn't match up with historical parameters.
As of today, stocks are still overvalued. In fact, even in March stocks were overvalued (more about that in a moment). Why, then, did stocks rally? There are a number of reasons, two of which are sentiment readings that had reached extreme levels of pessimism, indicating that pretty much everyone who wanted to sell had sold. Additionally, investor's pent up urge to buy after a 55% decline had to be relieved.
Based on those two and other indicators, theETF Profit Strategy Newsletter issued a Trend Change Alert on March 2nd, just a few days before the market bottom. As per the Alert, the ensuing rally was expected to be broad and powerful with a target of Dow (NYSEArca: DIA - News) 9000 - 10,000, and S&P 950 - 1,050.
Return to fair values
As the past few weeks and months have shown, stocks can rally over the short term despite fundamentally disturbing news and over valuation. Eventually, however, when reality catches up with the financial dream world - values are reset. The market's way of resetting values is via major corrections, some called recession others depression.
Depressions are most rare and follow a period of extended overvaluation. A look at the above GDP numbers shows that the market has been rising despite declining productivity. Furthermore, values haven't been reset seriously since the Great Depression.
But even a look at bear markets, such as the ones in the 70s and 80s, shows that stocks declined far enough to establish a fair value. Such fair value levels could be measured by P/E ratios and dividend yields. No prior bear market has truly bottomed unless P/E ratios and dividend yields reached rock bottom levels.
During the 2002 market bottom, P/E ratios and dividend yields did not reach fair market levels, that's why the 2002 lows were broken in 2009. Based on historic parameters, stocks are grossly overvalued at current prices. Investor optimism has reached the highest level since the 2007 all-time highs (remember how extreme pessimism signaled the March lows?), indicating that short and long-term, the stock market has, or is about to reach a pivotal turning point.
The October issue of the ETF Profit Strategy Newsletter includes a detailed analysis of value metrics (such as P/E ratios and dividend yields), along with a target range for the ultimate market bottom and the end of this rally.
What will you do with your rattling new car? Will you accept the excuses and continue to own a faulty product, or will you return it? With the recent rally, the market is giving you a chance to return 'rattling' overpriced stocks at a fair selling price. |
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发表于 2009-9-18 01:06 PM
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