To cite two: Shares may be more expensive than they’re telling you. And the market value of non-financial U.S. equities is within ~15% of the Oct. 2007 peak, implying that “most of the last three years was little more than a bad dream. Do you believe that?”
by Brett Arends, WSJ
Two words: Bah, humbug.
I can’t cheer this Santa Rally. Call me Scrooge. But I’ll give you ten reasons why not — and they don’t even mention the dismal economy.
1. Shares may be more expensive than they’re telling you. Wall Street says the market is still reasonably priced, at about 14 times forecast earnings. But two other measures tell a different story. The “Cyclically-Adjusted Price-to-Earnings Ratio” compares share prices to average earnings for the last ten years, not just for one year. And a measure called “Tobin’s q” compares share prices to the cost of replacing company assets. These may seem off-the-wall measures, but for more than a century they have proven very good guides for long-term investors. Right now both say the market is about 75% above its average value: Not a bubble, but expensive. These don’t mean the market will tank. But they do suggest your long-term returns from here may be modest.
2. Bargains are hard to find. Value investors are gasping for air. Looking for stocks below, say, 16 times likely earnings, and with a dividend yield of more than 3%? Good luck. Once you weed out shares of companies on life support or those with meager interest cover, you’re left with a smattering of decent-sized names – mostly drug companies and utilities, plus a handful of others such as Chevron and Kraft. In a market that’s reasonably priced, you typically find lots of stocks on the bargain rack. Not here.
3. Is that really it? The stock market is now where it was before Lehman Brothers collapsed. And if you exclude financial stocks, the market value of U.S. equities is now within about 15% of the October, 2007, peak. To believe that (non-financial) stocks are reasonably valued today implies that they were pretty reasonable then, at the peak of the bubble – and that therefore most of the last three years was little more than a bad dream. Do you believe that? Do I?
4. The dividend yield is dismal. As the market has rallied, the yield has tumbled. Today it’s just 1.7%, very low indeed by historic standards. David Rosenberg at Gluskin Sheff says the long-term average has been about 4.4%. Of course, dividends aren’t the only way for investors to make money: Stock buybacks and growth can also generate returns. But dividends have historically been a key driver of investment profits, and the current level is paltry.
5. Corporate debts are far larger than people realize. Wall Street is selling a story that corporate balance sheets are in great shape and U.S. companies are simply awash with spare money. It’s misleading. Some companies, naturally, are fine. But overall, corporate debts have been rising, not falling. Federal Reserve data show non-financial corporations owed $7.4 trillion at the end of the third quarter – an increase of $250 billion in a year, and a new record. As recently as 2005 the figure was just $5.5 trillion. The Fed says nonfinancial corporations now have debts equal to 58% of their net worth – compared to just 41% five years ago. And when you add these debts to the value of equities, the so-called “enterprise value” of public companies is now about 2.2 times annual sales, according to FactSet. That’s an extreme level – far higher than in 2006 or 2007, and exceeded only by the madness of 1999-2000.
6. Systemic leverage is through the roof as well. After three years of alleged “deleveraging,” U.S. households have managed to slash their enormous mortgage and other debt burdens by all ofâ€¦ 3.5%. Meanwhile government and corporations have borrowed much more. Net result? Total debts have risen 15% since the fall of 2007 to $36 trillion. Maybe this is okay, maybe it isn’t. There are brilliant economists on both sides. But more leverage means more risk. That’s economics 101. Yet here we are, the market is booming, and everyone seems to think everything is just hunky-dory.
7. Money managers too bullish. Global money managers are taking an upbeat view of stocks and the economy, and 40% are already overweight stocks in their portfolios, according to the latest survey by Bank of America/Merrill Lynch. And these money managers aren’t holding much cash in reserve: Just 3.5% of the average portfolio, a very low level. Even hedge fund managers, those skeptical souls who are supposed to puncture any market euphoria, are dangerously cheerful. Hedge fund managers have turned “extremely bullish on U.S. equities,” according to the latest TrimTabs/BarclaysHedge survey. Yikes. According to Bank of America, hedge funds are already heavily betting on a rising market – oh, and their leverage is now at “the highest level reported since March 2008.”
8. So is everyone else. An astonishing 63% of retail investors are now bullish, says the latest survey by the American Association of Individual Investors. That’s an extreme level. Just 16% are bears – half the long-term average. And the weekly survey by Investors Intelligence shows advisors are now more bullish than at any time since the peak in October, 2007. Strategists polled by Barron’s, our sister magazine, earlier this month predicted a hefty 10% stock market gain next year. Media sentiment is very bullish: Take a look at the stories looking ahead to 2011. Sorry, folks, but all this is bearish. The time to buy stocks is when everyone hates them.
9. Too many people I trust are cautious. Sure, you can hear lots of Wall Street strategists talking up the market, just as you can hear lots of Chrysler salesmen talking up Chrysler cars. But I can remember Wall Street strategists telling us it was a great time to buy stocks back in 2000 – just before the worst decade in memory. The people who have been right over the past decade are mostly still gloomy. That includes Mr. Rosenberg at Gluskin Sheff, and Albert Edwards at S.G. Securities. It includes John Hussman at Hussman Funds, who calls this a terrible moments in which to invest in stocks. And it includes Jeremy Grantham at GMO. While he still likes high quality blue chip names and emerging markets, his latest analysis suggests that large cap U.S. stocks are unlikely to beat inflation by much over the next seven years, while small caps will actually lose value.
10. A Santa Rally doesn’t mean a happy New Year. The market has risen 10% this quarter. So what? It did the same before Christmas, 2001 – then crashed in 2002. We had an 8% Christmas rally in 2002, followed by a nearly 4% slump. And after a 9% gain in the fourth quarter of 2004, the market dropped 3% in the next three months. Are strong Santa rallies usually followed by strong starts to the New Year? Not really. I checked the data from the last thirty years, and shares rose by just under 2% in the average first quarter. On the 16 occasions when it followed a Christmas rally of more than 5%, the average first-quarter gain was just over 2%. Like I said: Bah, humbug.