Avoiding the Bear Market Trap

April 30, 2001

Stocks Remain Hugely Overvalued!

With stocks posting gains last week far greater than earnings growth, overall equities became even more overpriced than in the prior week. The S&P Earnings Yield (dividends + retained earnings) at the end of this past week was 3.99%, while the 10 Year U.S. Treasury which stood at 5.33% And the Barron's index comprised of highest grade corporate bonds stood at 7.20%. Setting the question of taxes aside (which do play a role), from a completely logical viewpoint, assuming there was little if any doubt about the AAA companies' ability to repay their debt, why would someone wish to invest say $1,000 in the S&P 500 (P/E equal to 25), which generates mere $40 (most of which is retained by the company) when he can buy a high quality corporate bond that puts $72 in cash in his pocket?

Perhaps the relatively high corporate rates compared to U.S. Treasury rates are telling us that there is a rather high probability that the most credit worthy companies in America will default. Indeed, my friend Ian Gordon would not argue with that view. Given his belief that we are in the beginning days of a Kondratieff winter, he expects corporate default rates to be extremely high over the years to come.

But even if you don't agree with Ian's scary prognosis for seemingly healthy companies defaulting on their debts, why would you buy stocks that are providing you with an intrinsic value that is not much more than 1/2 what you can get from being a lender to large corporations? The answer you hear most frequently to that question is that stocks offer an element of growth which bonds do not. But that is most likely a very misleading argument at this late stage of the greatest bull market of all time. If anything, stocks will now need to yield far less than their long-term average of 9%, just to pull long term returns back to down to mean levels of return. Indeed, if our beliefs about the future prove to be correct, we could see negative returns for the equity markets for several more years.

I truly believe what we have working here is one giant "whore house" called Wall Street, which is sees no way out if it is to remain successful than selling Americans a lie. The only thing a huge population of equity industry folks can do is sell stocks, so sell them they must and at any cost to their souls. The perpetuate the myth that Alan Greenspan and the Federal reserve have found a way to put you on easy street for the rest of your life and that somehow the laws of nature are different this time.

If you can avoid being sold the huge lie told by Wall Street, namely that by continually printing money, uncle Alan Greenspan can ensure you that your wealth will rise perpetually, then you will be in a much better position not only psychologically to face up to the real truth of the matter, namely that we are headed for the hardest times since the Great Depression, but you will also be in a position to protect your wealth and perhaps even post relative gains while others "go through the wringer." Certainly that was true during the 1930's when those who owned gold in the form of Homestake Mining Co. fared exceedingly well compared to those without any gold ownership.

The Fed and government officials, having denied the reality of the death defying debt trap we are in, will attempt to defy the inevitable. They have already begun to do so evidenced by the Fed's most recent rate cuts which in fact are nothing more than an injection of a lethal drug called "dollars" into our monetary system. Why are more dollars lethal? Because to create more dollars in our fractional reserve monetary system, additional debt must be piled on top of an already overburdened system. In fact, by so doing, Mr. Greenspan is repeating the same mistakes that led up to the 1929 Crash. So, we think the respite the bulls have enjoyed over the past few days will prove to be short lived and nothing more than a bear market trap that will serve to spring even more pain and suffering on average Americans.

O'Higgins exposes Wall Street distortion

We have not spoken recently about the O'Higgins approach to investing but it retains a great deal of credibility in your editor's mind. In fact, along with a belief in the virtues of gold or some other form of honest commodity money, the O'Higgins approach lies at the heart of our investment philosophy.

O'Higgins has demonstrated that Wall Street has been full of baloney for many years, though the spin and deception have for sure gotten worse in recent years as the Street tries desperately to suck unsuspecting investors into stocks so they can extract more commissions and /or bail out of their own long positions.

To see how much better you would have done over the years by following the highly logical value orientated O'Higgins approach rather than following the advice of the self serving Wall Street talking heads, you need to examine the results. What are those results?

$1,000 invested in the Dow on 1/1/72 and held until 12/31/00 would have turned into $34,161, dividends included. However, $1,000 invested using the O'Higgins approach would have turned into $416,970 during that same time frame – 12 TIMES GREATER ! How was this accomplished? Here is how.

1. the process avoided major losses suffered during bear markets for stocks. In other words the O'Higgins process avoids the LOC trap. (LOC stands for "Lost Opportunity Cost" by being in bonds during years when the stock market suffered major losses.

2. Applying a trick using the gold price from one year to the next, the O'Higgins process has been able to predict the direction of interest rates from year to year 94% of the time. Accordingly most of the time, when the decision was to buy bonds rather than stocks, the O'Higgins approach correctly placed you either the short or long end of the yield curve.

Whether the O'Higgins approach can continue to work as well into the immediate future I have my doubts. The time frame during which the O'Higgins approach does not cover anything like the Great Depression. And as regular subscribers know, we think the odds favor another period of economic contraction similar to the Great Depression. Also, as regular subscribers know, this period in the long Kondratieff cycle is when paper assets are trashed in favor of the time honored currency that has outlasted all others, namely gold. Accordingly, our investment strategy calls for a marriage of the logic applied by O'Higgins and the use of gold as a hedge against a total loss of confidence in currency.

For more about using O'Higgins and gold, visit the web location shown below, and click on the "Profits & Risks" page.

According to the Talmud you should keep one-third of your assets each in land, business interests, and gold.

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