SUMMARY - "Hedger's Delight" :
The Contrarian's View is published 11 times per year on a mostly-irregular schedule, and the views expressed are those of the author and editor, Nick Chase. Because nobody can predict the future, results of past suggestions or recommendations are no guarantee of future results. Material in this publication may be freely quoted provided proper attribution is given to its source. Subscription rate: Free on the Internet through the World-Wide Web service at Assumption College. Using your favorite Web-browsing program, Open URL http://www.assumption.edu. Mailed paper subscriptions, one year for $39 to The Contrarian's View, 132 Moreland Street, Worcester, Massachusetts 01609. There is a limit of 50 paid subscribers at one time; please check for availability before sending any money. Sorry, Visa and Mastercard are not available. Overseas subscription rate, U.S. $54. Unsolicited material sent to us by UPS or by courier other than the postal service is refused and returned to sender! Phone: (508) 757-2881
You were expecting me to say "undervaluation", right? Well, sometimes yes, and sometimes no. But what almost universally occurs after periods of extreme overvaluation, such as the current one, is at least a return (and sometimes a violent, abrupt return) to more normal valuations for stocks. Consider the historical record:
First, let's take a look at monthly offerings of new issues of stocks, and of secondary offerings of new stock. When these two, taken together, reach extreme peaks, the stock market usually tumbles soon after, as shown in the table that follows.
Period Issue Peak Subsequent Advance/Decline early 1962 105 -22% early 1969 135 -30% late 1972 120 -46% Spring 1983 140 -16% mid-1986 145 +40%, then -31% early 1994 145 +21% (to date), then ?In the past 35 years, for the most part new-stock-issue frenzy has essentially coincided with market tops; the next bear market began almost immediately. The past two cycles are the exception. Following the peak in mid-1986, stocks (as measured by the popular averages) soared in the prelude to the 1987 Crash; then the Crash itself only returned stocks to the levels they were at before the feeding frenzy began. In the current cycle, the peak was reached in January and February 1994, when (in my opinion) the majority of stocks peaked; but this did not inhibit another feeding frenzy in the high-cap stocks which make up the popular averages. I leave it to you to speculate what the eventual dénouement will look like.
Another, very traditional and historically-accurate indicator of an overheated stock market has been the price-to-dividend ratio (the inverse of yield). When the P/D ratio is over 30, you are throwing your money at yesterday's success stories, for the odds that stocks will continue to rise are slim. Similarly, when the P/D ratio is less than 17, pessimism is being overdone, and a brighter day lies just ahead, though nobody can yet see it.
Investing With Price/Dividend Ratio >30 Period Stocks Were Up/Down 1 year later -0.2% 2 years later -2.3% 3 years later -6.9% 4 years later -1.2% 5 years later +4.7% 8 years later +19.7%Eight years is a long time to wait to make as good a return on your stocks as "investors" have become accustomed to making in one year. In the current cycle, the P/D of 30 was reached in October 1991; and, four years later, stocks are up 53%.... this time, the rule did not seem to apply. "This time is different", we are told.... because of the supposedly-low level of interest rates. Every feeding frenzy needs a rationale; this time indeed was different, but that does not guarantee the difference will continue.
Blue-chip stocks now trade at a P/D ratio of 43.... greater than the ratio before the Crash of '29, and the highest since 1906 (when the economy was younger than today's, and nearly every issue was a growth stock). Historically, when stocks have traded at a P/D ratio greater than 35, they were 6.7% lower a year later. The 1994 correction/minibear looked like it was going to validate the pattern, but the present tulipmania has instead shattered it.
Another measure of overvaluation is the ratio of T-bill to stock yields (which, as a relative measure, negates the "low level of interest rates" argument). Historically, when the T/S yield ratio was 2.2 or greater, stocks seldom made further headway and, indeed, frequently were making a major top such as in 1929, 1968/69, 1972 (for the "Nifty Fifty") and 1987. Currently the T/S ratio is about 2.2, indicating that investors are again overpaying for the merchandise, no doubt because they firmly believe the next recession won't appear before the year 2020.
Other measures of overvaluation, which relate to the size of the economy rather than just to past per-formance or to interest rates, seldom occur, but we're at them now. One is the percent of their assets people have in stocks, after correcting for pension-fund assets.
Period Peak Subsequent Stock Decline early 1969 39% -38% (in 1974) late 1995 38% ??A measure of a "strung-out" economy is the ratio of nonfinancial debt as a percent of Gross Domestic Product. This moves in very long cycles; it was not a factor in the 1968/69 peak, for example, but is present with us again today.
Period Peak Stock Behavior late 1928 195% +35%, then -89% early 1993 190% +27%, then ??Incidentally, as the Great Depression unfolded, nonfinancial debt rose to 280% of Gross Domestic Product, because GDP shrank while the government tried to borrow its way into prosperity. At least back then the Federal government was solvent; would the Feds have the wherewithal to bail us out of a similar situation today? The deficit would rise from the current $5 trillion to $11 trillion in only two or three years, and I doubt the dollar would be worth much in the international markets, even if our economy should survive such a crushing debt load.
All of these measures of fundamental overvaluation have caused the very best investment advisors, those who have made their clients' capital grow in both bull and bear markets, to be very cautious in the latest feeding frenzy. Today, their long-term records are ignored; what seems to matter is only that many of them underperformed in the 1995 rally. But these wizened souls have (mostly) lived long enough to know that the economy does not sail along smoothly forever; that inflation will not always be benign; and that interest rates are not preordained to forever gently decline.
What could upset the applecart? Many "doom-n-gloom" gurus look for political unrest.... which is always possible.... or for natural disasters (we've been waiting a long time for California to slide into the sea in an earthquake). But usually a change in financial conditions.... such as a recession... is what causes investor psychology to shift. I still recall the 1958-59 recession, which was totally unexpected and in which the Federal government's operations shifted from a slight surplus to an enormous deficit. The equivalent today would increase the deficit from the current $280 billion to about $650 billion, at which point the federal government would be consuming about 85% of all newly-generated capital. I doubt that starving businesses of new capital would lead to much economic recovery or to lower interest rates... or to ever-higher stock prices.
Even absent a recession in the near future, the history of prior extreme levels of overvaluation tells us we should expect, as a minimum, a return to the levels that prevailed before the current speculative frenzy.
However, we're about to enter the end-of-the-year "safe period", when fund distributions and tax considerations keep share prices propped up. Since stocks need to decline about 15% before a crash occurs, though the odds of a crash.... still at 85%.... have not changed, the odds of it happening this year (November or early December) are only about 1 in 3; more likely is that the bear will set in (or return, depending on your point of view) early in 1996. Though timing is always speculative (translation: I can foretell the future as well as anybody, which is to say, not at all), all measures of risk versus reward are shouting out that you should now be in cash or short, because the decline will come, and it will be a very major bear market, perhaps spanning several years.
One area of investing that's looking up after being in the doldrums for many months is the precious-metals shares. The inflation numbers, which have been benign these many months, will take a surprising upward jump in the first half of 1996 (if the government doesn't fudge them), and that is likely to send the price of gold well above $400 an ounce and ignite the gold shares. Should the same inflation numbers also accelerate the decline in stocks, you can add in a "flight to safety" factor that would drive gold shares even higher. This is probably only a short-term play, good until the middle of next year; but both supply of and demand for gold have been declining in tandem, and it now wouldn't take much of an increase in demand for gold to lift its price skyward.
This month, I show the results of my portfolio liquidation (mostly) described last month. The total liquidation value of the three portfolios, "Hedger's Delight", "Present and Future Income" and "Crapshooter's Folly", was $32,361.79. Of this, I am withdrawing (actually, have already spent) three-fourths for personal use; the remaining one-fourth has been put into the new "Phoenix" portfolio, for an initial value of $8,090.45, of which $6,771.95 is cash, and the remainder is the five options from "Hedger's Delight" which had value on September 30, 1995, plus 46 shares of Citizens Utilities fom "Present and Future Income". One thing I will do differently in the "Phoenix" portfolio is include the income and yield from the money-market fund, since there is currently no margin borrowing, nor do I expect there will be any for some time.
Though the "Phoenix" portfolio is new, past performance will not be discarded. Taking one-fourth of the combined values of the discontinued portfolios on January 1, 1987 gives us $7,134.81, which now becomes the vaue of the "Phoenix" portfolio "as if" it were begun at the beginning of 1987.
A. "Hedger's Delight" - real portfolio, includes commissions:
SUMMARY - "Hedger's Delight" :
Original cost: $10,455.77
Liquidation value: $ 3,967.85
Increase: $-6,487.92 [-62.05%]
The performance of this portfolio from January 1987 to September 30, 1995 (adjusted for the dilutive effect of added cash) was - 61.06%, for a compound annual rate of return of -10.20%.
B. "Present and Future Income" - real portfolio, includes commissions:
SUMMARY - "Present and Future Income" :
Original cost: $ 9,548.98
Liquidation value $12,132.63
Increase: $ 2,583.65 [27.06%]
The performance of this portfolio from January 1987 to September 30, 1995 (adjusted for the dilutive effect of added cash) was +42.18%, for a compound annual rate of return of 4.11%.
C. "Crapshooter's Folly" - real portfolio, includes commissions:
SUMMARY - "Crapshooter's Folly" :
Original cost: $10,817.13
Liquidation value: $16,531.31
Increase: $ 5,714.18 [52.83%]
The performance of this portfolio from January 1987 to September 30, 1995 (adjusted for the dilutive effect of added cash) was +68.39%, for a compound annual rate of return of 6.14%.
Continuing Portfolios:
The combined performance of the portfolios (including predecessors, but excluding "PIG" and TIAA/CREF) from January 1987 to the present, adjusted for the dilutive effect of added cash, is +49.69%, for a compound annual rate of return of 4.69%. For comparison purposes, from January 1, 1987 to October 27, 1995 (8.822 years), the CREF stock unit value (whose performance closely parallels the S&P 500 with dividends reinvested) has risen 188.07%, for a compound annual rate of return of 12.75%. WARNING: I am a rotten stockpicker. Prices shown are as of October 27.
SUMMARY - "Phoenix":
Original cost: $ 8,090.45
Present value: $ 8,157.47
Increase: $ 67.02 [7.63%]
Yield: $ 383.86 [4.75%]
The performance of this portfolio and its predecessors ("Hedger's Delight", "Present and Future Income", "Crapshooter's Folly") from January 1987 to the present is +14.33%, for a compound annual rate of return of 1.52%.
B. "Professors' Investment Group (PIG)" - investment club portfolio.
SUMMARY - "PIG" :
Portfolio cost: $ 3,825.00
Present value: $ 4,369.96
Increase (decrease): $ 544.96 [14.25%]
COMMENT on "PIG": At their last meeting, the professors instructed me to put a stop-loss on Cabletron at 65 or higher. (At the time, Cabletron was trading in the mid-fifties.) When the stock suddenly rose near 70, I put in a 5% trailing stop, beginning at 65; and I raised the stop price each day until I finally reached 75-1/2 (with the stock trading above 79). The stop was hit in the current correction, and the professors have a nice gain to their credit. Wouldn't it be nice if the other holdings would give similar gains?
C. Fidelity IRA - real portfolio, includes commissions:
SUMMARY - IRA:
Original (1983-86) cost: $ 8,326.19
Present value: $19,025.25
Increase: $10,699.06 [128.50%]
Current yield: $ 886.19 [4.49%]
The performance of this portfolio (including its predecessors) from January 1, 1987 to the present is +73.47%, for a compound annual rate of return of 6.45%.
F. CREF Pension plan; I switch between indexed stock/bond/money funds:
Date Sold Bought
13Mar92 stock @ 56.65 MM @ 13.41
29Apr92 MM @ 13.48 bond @ 31.19
19Jun92 bond @ 32.14 MM @ 13.55
29Jun92 MM @ 13.57 stock @ 56.74
24Jul92 stock @ 56.76 MM @ 13.61
29Oct92 MM @ 13.72 stock @ 58.61
23Dec92 stock @ 61.48 MM @ 13.78
16Jan95 MM @ 14.83 equity-index @ 26.44
20Jan95 eq-index @ 26.19 MM @ 14.84
Values, 27Oct95: stock, 85.70; MM, 15.51
Gain, 1988: 18.91%; 1989: 14.48%; 1990: 8.28%; 1991: 27.93%; 1992: 10.20%; 1993: 3.08%; 1994: 4.07%
Gain, January 1 through September 30, 1995: 3.34%
Total gain since January 1, 1988 (7.75 years): 127.93%
Compound annual rate of return: 11.21% (My long-term target: in excess of 15%)
Gain shown excludes the impact of additional monthly cash contributions.
Buying CREF stock on January 1, 1988 and holding it gained 179.14%, for a compound annual rate of return of 14.17%.
COMMENT on "Timer's Trend" : A good, clean sell signal came on October 9, at which point I advised everybody via the "computer warmline" to exit stocks. Then, to my consternation, "Timer's Trend" whipsawed (in hindsight) on October 13. But now it is again bearish, and whipsaws are to be expected at major market tops. If you faithfully follow the indicator, you have a fat profit (18%) for 1995.
{, } = "Timer's Trend" (4% and 10% exponential) SELL ({) or BUY (}) signal
=============================TIMER'S TREND===========================
Mon 19 Jun 95 . | . # | 4553.68 |~.~~+~~~~~~~~~~~~~~~~~~~~~~~~~~~*
Tue 20 Jun 95 . | .# | 4550.56 | . + *
Wed 21 Jun 95 . | .# | 4547.10 | . + *
Thu 22 Jun 95 . | . # | 4589.64 | . + *
Fri 23 Jun 95 . | # | 4585.84 | . + *
Mon 26 Jun 95 . | # | 4551.25 | . + *
Tue 27 Jun 95 . | # | 4542.61 | . + *
Wed 28 Jun 95 . | # | 4556.79 | .+ *
Thu 29 Jun 95 . | .# | 4550.56 | .+ *
Fri 30 Jun 95 . | . # | 4556.10 | .+ *
Mon 3 Jul 95 . | . # | 4585.15 | . + *
Wed 5 Jul 95 . | . # | 4615.23 |~.~~+~~~~~~~~~~~~~~~~~~~~~~~~~~~*
Thu 6 Jul 95 . | . # | 4664.00 @|~.~~~+~~~~~~~~~~~~~~~~~~~~~~~~~*
Fri 7 Jul 95 . | . # | 4702.73 @| . + *
Mon 10 Jul 95 . | . # | 4702.39 @| . + *
Tue 11 Jul 95 . | # | 4680.60 @| . + *
Wed 12 Jul 95 . | . # | 4727.29 @|~.~~~+~~~~~~~~~~~~~~~~~~~~~~~~~~*
Thu 13 Jul 95 . | . # | 4727.48 | . + *
Fri 14 Jul 95 . | .# | 4708.82 | . + *
Mon 17 Jul 95 . | . # | 4736.29 | . + *
Tue 18 Jul 95 . | #. | 4686.28 | . + *
Wed 19 Jul 95 # I . | 4628.87 |~+*~~~~~~~~~~~~~~~~~~~~~~~~~
Thu 20 Jul 95 . I . # | 4641.55 | .+ *
Fri 21 Jul 95 . I .# | 4641.55 | .+ *
Mon 24 Jul 95 . | . # | 4668.67 | .+ *
Tue 25 Jul 95 . | . # | 4714.45 | . + *
Wed 26 Jul 95 . | . # | 4707.06 | . + *
Thu 27 Jul 95 . | . # | 4732.77 | . + *
Fri 28 Jul 95 . | .# | 4715.51 | . + *
Mon 31 Jul 95 . | .# | 4708.47 | . + *
Tue 1 Aug 95 . | # | 4700.37 | . + *
Wed 2 Aug 95 . | . # | 4690.15 | . + *
Thu 3 Aug 95 . | .# | 4701.42 | . + *
Fri 4 Aug 95 . | . # | 4683.46 | . + *
Mon 7 Aug 95 . | .# | 4693.32 | . + *
Wed 9 Aug 95 . | # | 4671.49 | . + *
Thu 10 Aug 95 . | .# | 4643.66 | . + *
Fri 11 Aug 95 . I #. | 4618.30 | .+ *
Mon 14 Aug 95 . | .# | 4659.86 | .+ *
Tue 15 Aug 95 . I # | 4640.84 | .+ *
Wed 16 Aug 95 . | . # | 4639.08 | .+ *
Thu 17 Aug 95 . | . # | 4630.63 | .+ *
Fri 18 Aug 95 . | . # | 4617.60 | . + *
Mon 21 Aug 95 . | . # | 4614.78 | . + *
Tue 22 Aug 95 . | .# | 4620.42 | . + *
Wed 23 Aug 95 . | # | 4584.85 *~.~+~~~~~~~~~~~~~~~~~~~~~~~~~
Thu 24 Aug 95 . | # | 4580.62 | . + *
Fri 25 Aug 95 . | .# | 4601.40 | .+ *
Mon 28 Aug 95 . | .# | 4594.00 | .+ *
Tue 29 Aug 95 . | # | 4608.44 | .+ *
Wed 30 Aug 95 . | . # | 4604.57 | .+ *
Thu 31 Aug 95 . | . # | 4610.56 | . + *
Fri 1 Sep 95 . | . # | 4647.54 | . + *
Tue 5 Sep 95 . | . # | 4670.08 | . + *
Wed 6 Sep 95 . | . # | 4683.81 | . + *
Thu 7 Sep 95 . | . # | 4669.72 | . + *
Fri 8 Sep 95 . | . # | 4700.72 @| . + *
Fri 8 Sep 95 . | . # | 4700.72 @|~.~~~+~~~~~~~~~~~~~~~~~~~~~~~~~*
Mon 11 Sep 95 . | . # | 4704.94 | . + *
Tue 12 Sep 95 . | . # | 4747.21 | . + *
Wed 13 Sep 95 . | . # | 4765.52 |~.~~+~~~~~~~~~~~~~~~~~~~~~~~~~~~
Thu 14 Sep 95 . | . # | 4801.80 | . + *
Fri 15 Sep 95 . | .# | 4797.57 | . + *
Mon 18 Sep 95 . | # | 4780.41 | . + *
Tue 19 Sep 95 . | . # | 4767.04 | . + *
Wed 20 Sep 95 . | . # | 4792.69 | . + *
Thu 21 Sep 95 . | #. | 4767.40 | .+ *
Fri 22 Sep 95 . I# . | 4764.15 | .+ *
Mon 25 Sep 95 . I # | 4769.93 | .+ *
Tue 26 Sep 95 . I .# | 4765.60 | .+ *
Wed 27 Sep 95 . I# . | 4762.35 | + *
Thu 28 Sep 95 . I . # | 4787.64 | .+ *
Fri 29 Sep 95 . | .# | 4789.08 | .+ *
Mon 2 Oct 95 . I #. | 4761.26 | .+ *
Tue 3 Oct 95 . I# . | 4749.70 | + *
Wed 4 Oct 95 . I# . | 4740.67 | + *
Thu 5 Oct 95 . I # | 4762.71 | + *
Fri 6 Oct 95 . I #. | 4769.21 |+. *
Mon 9 Oct 95 .# I . {| 4726.22 |+. *
Tue 10 Oct 95 . #I . | 4720.80 + . *
Wed 11 Oct 95 . I . # | 4735.25 |+. *
Thu 12 Oct 95 . I . # ]| 4764.88 |+. *
Fri 13 Oct 95 . | . # }| 4793.78 | + *
Mon 16 Oct 95 . | #. | 4784.38 | .+ *
Tue 17 Oct 95 . | .# | 4795.94 | . + *
Wed 18 Oct 95 . | .# | 4777.52 | . + *
Thu 19 Oct 95 . | #. | 4802.45 | .+ *
Fri 20 Oct 95 . I# . | 4794.86 | + *
Mon 23 Oct 95 . #I . {| 4755.48 | + *
Tue 24 Oct 95 . I# . | 4783.66 |+. *
Wed 25 Oct 95 . #I . | 4753.68 + . *
Thu 26 Oct 95 #. I . | 4703.82 |-. *
Fri 27 Oct 95 .# I . | 4741.75 | - *
=====================================================================
[, ] = 4% exponential change unconfirmed by 10% exponential (not a signal).
@ = market overbought or oversold. I or & (on baseline) = 10% exponential SELL.