The Stock Market: A Coming Story Of WoeWhat happens in the stock and bond markets has great impact on the precious metals market; how could they not? Many trillions of dollars from decades of past inflationary "injections" from the Federal Reserve are currently circulating in the financial markets, money that's fated to one day flow into something, anything other than a stock or a bond. What keeps all these dollars in the financial markets today? Misguided expectations of a suitable return on investment for retail investors and prudent-person standards for professional money managers whose primary goal is job security. But in bear markets, Mr Bear finds great satisfaction frustrating the hopes and dreams of investors and money managers alike.
Are stocks still in a bear market? For many reasons, I can say they aren't in a bull market. Since January 2000, the Dow Jones has seen two major bear markets: one just short of being a new -40% bear bottom in 2002, and then in 2009 the Dow saw its second deepest bear market bottom since 1885. Excluding the 1930s, the 2000s have been the most brutal decade in the history of the stock market. And now in June, 2012, we find the Dow Jones in a "just-a-bit" market: just-a-bit above its highs of 2000, and just-a-bit below its highs of 2007. But the fact is, that even at the Dow Jones bottom of March 2009, stock prices have been grossly over-valued by historical dividend standards since the early 1990s; over two decades now.
Below is the chart plotting the dividend yield for the Dow Jones since 1925. For decades, the standard rule-of-thumb for timing the stock market was to exit the stock market when the yield for the Dow Jones approached 3%, and stay out until the Dow Jones once again yielded over 6%. It was, and I expect will still prove to be an excellent rule to safeguard investors from the ravages of Mr Bear for the next few years. In other words, stay out of the stock market until the Dow Jones dividend yield once again rises to some point above 6%, possibly as much as 8%.
The thing to note is how well the Dow Jones' dividend yield rule worked from 1925 to the very start of the Greenspan Fed. Yes, this rule didn't provide investors with the precise tops and bottoms of the stock market, but it did move investors into the market, and kept them in during the bulk of all the pre-Greenspan era bull markets. This rule also provided investors a rational theory of values that prevented them from taking crippling losses during bear markets.
After August, 1987, Alan Greenspan became one of the most popular people on Earth because he never missed an opportunity to frustrate the stock market's price-discovery mechanism from finding its actual free-market valuation. During the 1990s, the Dow Jones' dividend model was out, and holding for the "long term" stocks whose valuation only seemed to increase was in. Thanks to the Greenspan Fed, at its January 2000 top, the Dow Jones yielded a perilous 1.30% as the world cheered the maestro on. For the past twelve years, investors and "policy makers" alike have struggled with the aftermath of the financial bubble Alan Greenspan inflated into the stock market.
Do you think dividend yields don't matter - no? Blue-chip stock yields were totally ignored by stock bulls, and the financial media in the late 1990s, as the Dow Jones' dividend yield declined relentlessly toward a historic low in January 2000. A Book predicting 36,000 on the Dow was a celebrated best seller at the 2000 top. The author (an academic) was interviewed by guess who? CNBC. Twelve years ago, few bulls were aware that the Dow Jones' cash payout was only $153.25, or cared. Why should they when double digit capital gains were there for the taking. Bulls were indifferent that at 36,000, the Dow Jones would have yielded only 0.425%. Twelve years ago, stock bulls were only concerned if the Dow Jones would see 36,000 in 2005 or 2006.
However, everything changes in a bear market, when thoughts of juicy capital gains become distant memories. Whether you know it or not, in bear markets, asset valuations are ultimately fixed by the risk premiums fearful traders assign to income producing investments, like grossly overvalued US Treasury bonds and the blue chip stocks, such as those listed in the Dow Jones.
Look at the Dow Jones' dividend yield at the bottom of the credit-crisis market low of March 2009. As the Dow Jones slipped 53.78% from its high of 14,164 in October 2007, its dividend yield increased to only 4.78%. Take another look at the chart above; a dividend yield of 4.78% is a long way from the traditional bear market all-clear yield of 6%! With the Dow Jones' cash payout of $310.43 in March 2009, had the Dow Jones seen the traditional 6% yield marking the termination of a bear market, it would have also seen a 63.47% decline from its highs of October 2007!
Had Congress in October 2008, on live TV, not given Treasury Secretary Paulson the financial "bazooka" he demanded to restore "stability" to the financial markets, I suspect even a dividend yield of 6% would not have placed a floor under a stock market whose valuation had been grossly inflated since 1987. And note that the range of Dow Jones dividend yields in the table above are all within the historical range of possible bear market bottoms.
But in big bear markets, dividend payouts also become vulnerable, and subject to deep cuts by companies in distress. In the early 1930s, the Dow Jones saw a reduction in cash payouts of over 70%. Here's a table listing valuations in the Dow Jones at various dividend cash payouts and yields. These valuations are based on mathematical relationships, and are * NOT * subject to debate.
Just because the Dow Jones hasn't yielded 6% since August of 1982, that doesn't mean that it can't happen again. And don't believe that somewhere it's chiseled in stone that the Dow Jones' yield of 10.38%, seen in July 1932, will never be exceeded; because it can. Also, when push comes to shove in hard economic times, the first thing a struggling corporation does is cut its dividend payout to make money available to service its debts. And in a bear market, should the Dow Jones' cash payouts begin to collapse, the Dow's valuation will be caught in the same pincers that proved so devastating to stock valuations in the Great Depression; rising dividend yields on falling cash payouts (see table above), and a major banking crisis on a global scale will do exactly that!
I have the distinct feeling that after almost three decades of Greenspan and Bernanke's "injecting liquidity" into the market for the express purpose of expanding stock valuations to keep their Wall-Street masters' and a gullible public in search of risk-free wealth happy, Mr Bear is going to break all downside records for the stock market before he's finished with the "policy makers", and you and me! Let me tell you something about Mr Bear; he is just the kind-of-guy who would enjoy doing exactly that, if you don't get out of his way.
"The prudent sees danger and hides himself, but the simple go on and suffer for it." --
Proverbs 27:12 (ESV)
Thanks Mark, I almost had a heart-attack reading this. The Proverbs quote was a nice touch too. But after a smoke and a couple of stiff drinks, I'm feeling better already because I know that anything is possible, including a mile-wide asteroid crashing the party on Wall Street, or the Dow Jones falling to 417. But the * REAL * question is; is something probable?
Well, light up another smoke, refill your drink and read on.
Here's a chart plotting each Dow Jones' 2% day since the beginning of 1900. A Dow Jones' 2% day occurs when the Dow moves 2%, or more, from its previous day's closing price and Dow Jones 2% days are common occurrences - during bear markets. One would think that in big bear markets, the largest percentage daily moves would be to the downside. But in fact the largest daily moves in big bear markets are double-digit UP DAYS. Mr Bear has something personal against short sellers - you've been warned.
So, since taxis were powered by horses on Wall Street, big bear markets have been volatile markets. But the chart above, while interesting, fails to properly visualize the concentration of volatile days that occur during bear markets. The best way to examine stock market volatility is to count the number of Dow Jones 2% days in a 200 day running count. Up or down 2% moves, or more, doesn't matter to Mr Bear, as he wants to inflict grievous harm to both bulls and bears. I call these 2% days, DAYS OF EXTREME VOLATILITY, as they occur so infrequently. Since the first trading day of 20th Century, to today (112 years), the NYSE has seen 30,551 trading sessions, of which the Dow Jones has moved 2%, or more from a previous day's close in only 1786 of them. So they are rare events on the whole, but very common during bear markets.
The results of my 200 day count are plotted below, and anyone familiar with the history of Dow Jones' bull and bear markets will recognize that with the exception of the October 1987 crash (the day computers ruled Wall Street) the spikes seen in the chart below are all associated with bear market bottoms.
There's a lot to be said about the plot above, but the thing for us to note are the two spikes in the chart: one for the great depression, the other for the credit crisis. One can understand these spikes in one of two ways:
- Proof the Great Depression bear market was worse than the credit crisis'
- The Credit Crisis event didn't become a Great Depression event because Congress gave the Federal Reserve and the US Treasury a multi-trillion dollar financial bazooka for blasting bears.
How different would this plot look today if a few years ago, the US government did the right thing by standing back and letting the big Wall Street banks and their sub-prime mortgages fail, and allowed all financial assets and commodities to find their own prices in a free market? I believe the credit crisis crash would have been much worse than the crash of 1929-32, in terms of the percentage decline of the Dow Jones, and the number of 2% days the Dow Jones saw on its way to the bottom. This would have been a horrible thing for sure. But at the end of the horror, the world would have put the poison of the past away, and we would now be living in a world without the unbearable burdens of trillions of dollars of ill-considered debt weighing on the economy, the government, and our lives.
As it is, to protect past debt creation that now serves no good purpose, market prices today for stocks and bonds are fixed (overpriced), and have been for a long time. So, I take the latter of the two positions above, because after the March 2009 bottom, the Dow Jones still sees too many 2% days in its 200 day moving count.
All of the problems of the past are still with us, because the "policy response" to the pending and unavoidable deflation of Washington and Wall Street's past economic and market blunders, is to kick their large garbage can down the road, always towards some unspecified date after the next election.
In the chart below, I have an above and below view of this data plotted in 60 year segments that better displays my concerns of the post March 2009 credit crisis bottom. The US Government spends vast sums of inflationary, make-pretend dollars to "stabilize" the stock market, but with all of the Dow Jones' 2% days since March 2009, Washington's "market stability operations" doesn't seem to be working as advertised.
This observation should be seen in light of the fact that after August 1971, when the US Government took the world's reserve currency off its last link to gold, the plot for this data began to oscillate as it never had before. Look at the charts; you can't miss what I saying. So, unchecked monetary inflation has created instabilities in the stock market. If this is true, and it is, past and future quantitative easings (QE), will increase market volatility (Dow Jones 2% days), and downward pressure on the American stock market. To prove my point, we need only wait to see what is to come.
So much for Dow Jones' days of Extreme Volatility; now let's all get another drink and move on to the NYSE's 70% A-D Days of Extreme Market Breadth. What is a NYSE 70% Advancing -Declining Day of Extreme Market Breadth? Well, for each day's trading at the New York Stock Exchange, we subtract the number of stocks whose price fell that day, from the number of stocks whose price advanced. We then divide that figure by the total number of shares traded that day to find the NYSE A-D ratio.
A-D/Total Shares Traded = NYSE A-D Ratio
A day of extreme market breadth occurs when the ratio is +/- 70%, or greater. Days of extreme market breadth are also EXTREMELY RARE; only more so than Dow Jones' 2% days. Since 1926, the NYSE has seen only 351 such days in 22,882 trading sessions at the NYSE. The table below lists the specifics.
Seeing a cluster of Negative 70% days is bad, but groups of positive 70% days are sure indications of intense activity by Mr Bear, and pain and suffering by everyone else during the Great Depression, and now again in the Credit Crisis bear market. The clusters of positive 70% A-D days below are markers of investors' distress in the stock market from 2007 to today. And please note that during the Greenspan era, which many declare as the greatest period of "growth" ever, there was not one positive NYSE 70% A-D day that occurred after 1988, until the sub-prime mortgage problem began impacting the financial markets in August 2007!
Seeing frequent NYSE 70% A-D days since the start of the credit crisis is not a coincidence, but a solid indication that past-unresolved issues are again surfacing in the financial markets. Heck, we've seen two -70% A-D days in the past ten trading days, and Friday's ratio was -69.68%!
Here is a link to Zero Hedge that provides a short, but intense summary of what is coming right around the corner. My only comment on this link is that the Dow Jones' days of Extreme Volatility, and the NYSE's Days of Extreme Breadth anticipated this development five years ago, February 2007.
Weekly Market Update
What a week, if you were a bear on stocks or a bull in gold and silver. This is a change in the pattern of the market, as usually bad weeks for the stock market are also bad weeks for gold and silver. Should this trend continue, then these two markets have finally decoupled from each other, which is how it should be. Remember, gold and silver don't benefit from monetary inflation; stocks, bonds and real estate do. The driving force behind bull markets for gold and silver is money fleeing deflating-overvalued stocks, bonds and real estate, into gold and silver!
Has the big move in gold and silver finally arrived? Maybe. What about my concerns that the "policy makers" will bushwhack the old monetary metals in the paper futures markets this summer? After this week, they have lessened. But when the Dow Jones approaches 10,000, we should expect desperate people to do desperate things, especially Wall Street's elite, people who live fabulous lifestyles by keeping things as they are. Declining valuations in financial assets and rising valuations in gold and silver place their situation in life, and connections to political power at risk. At the social levels they live at, failure to perform has consequences. Who knows what will happen in the coming year? Maybe someday soon Jon Corzine will see his day in court, at the insistence of a political class that no longer cares to curry favors from Wall Street's "Masters of the Universe", who can no longer perform as promised.
Let's see what gold and its step sum are doing. Gold has turned a corner, and the step sum looks like it will too. But the big move in gold so far is only a one day event, Friday. Sorry to say that one trading day is insufficient to move the step sum noticeably. Next week has five trading days. If today's move was not a one day wonder, we'll see it in next week or two in the step sum. But don't be surprised to see gold turn around and go the other way either. My bullishness on the old monetary metals is based on long term fundaments, not what happened today, or next week.
I received many requests to do a step sum chart for silver. So as requested, here it is. Both silver and its step sum have stopped going down. It appears that the low prices of last January are going to hold. Don't worry if we don't see a big move up in silver below, as we did for gold above. Gold was only 17% below its last all-time high, and moved 3.74% today. But silver started trading today at 43.10% from its last high of the move (late April 2011), and only increased by 2.84% today. So differences between gold and silver has more to do with my charts' scaling than what actually happen in the market today. If silver is about to run again, we'll see it in its step sum before its price in the chart below.
The Dow is going down, and market sentiment (the step sum) is not arguing the point.
Anyone risking money on financial companies for the past three years has wasted their time. In the coming year, I expect investors in these toxic assets will waste more than just their time. Today, the NYSE Financial Index closed 60% below their highs of 2007. These "to-big-to-fail" companies have BIG problems that most likely will not be resolved until their "fortress-like balance sheets" are consumed in a financial black-hole of their own making.
Let's look at their step sum and price action; since May 18, their step sum moved up four steps with almost no effect on their price. Then in one trading day (one down step in the sum) the NYSE Financial index declined noticeably downward. This tells us that the NYSE Financial Index finds it easier to go down than up, which is something I would never risk my money on.
I follow this chart closely, as these same financial companies were the one stock group that caused the massive collapse in all the other stock groups in 2008-09. When the financial market's payment system breaks down, so does everything else. Today CNBC was wondering if Morgan Stanley was going to be downgraded by one or two notches by the credit rating agencies. Does it matter? We live in a world where bank reserves are full of sovereign debts and abandon mortgages; assets that are liquid (sellable in size) only because Europe's central banks and the Federal Reserve are there to buy junk assets that no one else wants? I expect we will see some excitement this summer.
2 June 2012
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