The general idea here is that true "revulsion" doesn't does not happen until PE ratios compress into the single digits as they did in the early 1980s. Edwards writes “as the equity bloodbath of the last decade enters its final, even bloodier phase..." so we have that to look forward to.
The argument relies on reversion to the mean which is backward looking. If this secular bear is to have a "third act" there is no reason it has to take the S&P 500 down to 450 just as there is no reason it has to stop at 450. Another point is that wherever a decline might bottom (450, 850, 150) it will probably not spend much time there. During the worst of the recent (current?) bear market the S&P 500 spent 23 days below 800 from February 17 to March 20. There was also one close in November below 800 and I bet you don't remember that one but the S&P 500 dropped 6.6% on November 20, 2008 to close at 752 and bounced back the next day to close at exactly 800.
There are many other instances of bear market lows being very quick despite the panic they engender. The point here is that for people who do not heed warnings from the market and lighten up early then whenever a low does come that means from there it goes higher, even if it takes a long time, so it is crucial to resist the urge to panic--try to remember the emotion in the market in March of 2008, go read the comments from whatever blogs you like from that time as a reminder because if the market scares down it means people will be scared (intended to be a very obvious comment).In many posts I have noted my belief that the longer term outlook for US growth and by extension equities is not great, that I expect many foreign markets to outperform over a period of years. Should there be another or final washout as Edwards is looking for it will surely take down just about every other foreign market, there will be no decoupling such that during a 30% drop in the SPX other markets will go up. This was true in 2008 and would be true again. However it is also true, this is a point I made before the 2008 declines started and it worked out this way, that many of these markets will go down less, go down on different timelines and come back sooner.
As I said a couple of years ago the important thing is to mentally prepare for a large decline. The current fundamentals stink, the bond market is visibly distorted and demand for equities is currently unhealthy (IMO anytime the SPX is below its 200 DMA demand is unhealthy). As John Hussman might say current conditions favor downside risk over reward at the moment. Maybe equities won't go lower from here ever again but that outcome is not what needs to be protected against (either in terms of trades placed or mental preparation to avoid panic selling).
I find it truly astounding how many professionals appear to be caught off guard by large downturns yet it always happens and will happen again even if the next downturn does not come until the next cycle. The biggest mistakes get made during times of panic, lack of readiness sets the stage for mistakes that get made during times of panic. This is universally true.
9 comments:
Having been a Bearon's reader for over 40 years, I believe I am qualified to comment on Alan Ableson for sure-"often wrong, never in doubt".
I used to consider Abelson a contrary indicator, until I realized he always was negative. So there went that indicator.
As another 40-yearer, there always has been an 'end-is-nigh' forecast. A Dow Zero, if you will. One day that forecast might prove correct.
Investors are either prepared for a wide variety of situations or they aren't.
BillM
I don't expect a major crash myself (but have dry powder just in case) yet somehow I keep coming back to the problem of distorted price signals: As a long-time investor I'm used to others trying to game me and this always included sources of information such as brokers and the need to compensate for the influence of government and/or central bankers too. However the list of suspect information sources is growing longer and now must include some of the (formerly) most reliable names in the financial biz.
For example, the major bond ratings agencies -- Moody’s, S&P and Fitch -- appear to have escaped almost completely undamaged (and unregulated) from the financial crisis even though they were pay-for-play evaluators who provided their highest stamp of approval to some of the worst junk in the history of debt. Literally at ground zero of the credit debacle; e.g., "Last month, a long-running Senate study determined that over 91% of the AAA mortgage-backed securities issued from 2006-2007 have since been downgraded to “junk” status of BB or lower" http://tinyurl.com/2bcvvyu
Even if one does not buy into conspiracy theory one would think that errors of this magnitude might have cost the agencies something -- maybe some investigations and a fine or three or even (be still my capitalist heart) the loss of some business -- but instead they prosper and are, if anything, more widely used and profitable than ever.
How is the invisible hand supposed to work if there is little apparent consequence for gross misfeasance and even a bond rating must now be considered suspect? I'd say the dark side of the moon (pace Roger Waters) is a reasonable metaphor for this state of affairs; little wonder markets seem bereft of direction and sense.
Good post RW.
That's why I like the diversification of bond funds, especially the super low expense kind. If the ratings agencies can't get it right, I probably don't have much chance of getting it right either.
I would point out however that some of the bond insurers have suffered tremendously, as they should. How were they performing their analyses?
What are your thoughts on comparing the relative yields of bonds versus earnings yields of stocks? Earnings yield = 1/(P/E) or E/P (as a %). I know a lot of people don't have much confidence in the numbers behind P/Es. Put that aside if you can.
WH, monoline bond insurers such as AMBAC and MBIA got hit hard after 'diversifying' their business from insuring staid muni's into insuring mortgage-backed products such as CDO's and added themselves to the sucker's list along with the other victims of the credit crash in consequence. FWIW I always thought of the monoline insurance biz as just another racket akin to the raters -- municipalities could get a better interest rate if they paid to have their bonds insured -- and usually ignored them when evaluating muni's but, unlike the raters, the monolines actually did have to insure something with hard cash and so were crushed when the crisis hit (they never had enough cash to pay the bill of a major event and everyone who was paying attention knew it).
Corporations may game the numbers but dividends are a bird in the hand and comparing earnings yields to bond yields remains a valuable tool (Graham and Dodd knew whereof they spoke). FWIW I am a believer in equity income as well, assuming it should be in most strategic portfolio mixes, but it has some pretty strict limits from my POV because equity income never 'matures' and must be evaluated as distinctly higher in risk as a result; i.e., risk/reward ratio is often not as favorable as yields might suggest. Bond funds also never mature but this is not so much a risk problem (assuming reliable agencies such as Vanguard) as it is a problem in estimating duration and portfolio impact.
RW,
You are indeed correct regarding the insurers. In fact, Vanguard did away with their insured tax exempt fund as a result of the debacle.
Regarding your comment,
"...strict limits from my POV because equity income never 'matures' and must be evaluated as distinctly higher in risk.."
You are correct of course, but duration provides us with a tool to assess certain characteristics of portfolio behavior.
John Hussman has an interesting article from 2/23/2004 "Buy-and-Hold For the Duration." in which he discusses the duration of an equity portfolio. Essentially, equity duration is the inverse of the dividend yield expressed in years. One can then take a weighted average of the fixed income/equity portions of a portfolio and determine the duration of the portfolio as a whole. Higher dividend yields have shorter duration etc. I think you would find this paper interesting assuming you haven't already read it. In my opinion, the concept kind of makes the case against oldsters buying low dividend growth stocks. Interestingly, that is exactly the behavior we see from our "seasoned citizens." I don't see much of reason to have a portfolio duration that exceeds one's life expectancy as Husman alludes to in his paper.
To me, this concept validates some of Graham's writings in a round about way.
I'm too tired and lazy to provide the link to Hussman's paper, but it made such an impression on me, that I made myself a printed copy.
I think if you look at most every historical chart imaginable, the time to purchase equities is when there is no good reason to do so... at that point the price reflects zero expectations, which are not hard to exceed over time... of course its a little difficult to explain to your clients (or your spouse or friends) why you are doing something that clearly makes no sense... but just as selling when things are fantastic, buying when things are bleakest is just a little too easy... most of us would rather complicate things... ;)
WH, can't recall that Hussman paper but if it made an impression on you I'll look it up.
RW,
Here's the link. I was tired last night.
http://hussmanfunds.com/wmc/wmc040223.htm
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