Rather than covering Lynn's calls that were mostly elemental (or tax questions that she couldn't answer) and probably not of much interest to my readers, I am going to give you a rare treat, courtesy of David Korn's August 16, 2009 newsletter (posted with David's permission).
David's guest-writer, Bill, discusses many things about the stock market that I'm sure you will find fascinating. Hope you enjoy reading this as much as I did....(Yo, DanG, ever hear of the "Manheim Used Vehicle Index" market indicator?) 8^)
AUTHOR: Bill (with editorial comments by DavidK)
Bill: I appreciate the opportunity to share my thoughts with David's subscribers. As David says in his introduction, I have been fascinated with the stock market for a very long time. It became such a passion of mine, that I decided to forego an engineering career in favor of helping people plan their financial future. Here are my thoughts on the current stock market environment.
March 9, 2009
Bill: March 9, 2009 is the day that will go down in the history books as the cyclical bear market low when the S&P 500 recorded a closing price of 676.53. While Bob Brinker will not go out on a limb and make a long term forecast, this 48-year old has taken the position that the March 9th lows will be the low price for the rest of our lives (and I plan to live another 40-50 years). Therefore, not only will this mark the cyclical bear market low, but I also believe March 9th will be recorded as the low for the secular bear market that began in the first quarter of 2000.
David EC: Now that's what I like, a specific forecast right out the gate. I am in agreement with Bill that a secular bear market began in the first quarter of 2000 and continues. The secular bear market insofar as the benchmark S&P 500 Index is concerned, began on March 24, 2000, when the S&P 500 recorded a high of 1527.46. I have maintained since then that the secular bear market is based on a price-to-earnings multiple compression that will result in valuation returning to the long-term mean. I also agree with Bill that a cyclical bull market began on March 9th, which also accompanied positive divergences in the market internals across-the-board as noted in my special alert on that date. As far as whether this will mark the ultimate bear market low, I tend to agree that the odds favor that at this juncture. However, I want to address a scenario where the March 9th lows get taken out ‹ the unthinkable, another terrorist attack on homeland soil which makes 9/11 seem like peanuts. That scenario is a dirty nuclear bomb. Do I have any idea if it will ever happen? No. And hope it won't. And I don't think you can really plan for that type of event because if it happens, money is probably the least of anyone's worries. About the best you can do is make sure your asset allocation is in order such that you can weather huge swings in the market. The last year and a half has hopefully brought that lesson home.
Bill: During the prior two secular bear markets which took place between 1929-1949 and 1966-1982, the absolute price lows did not occur at the end of the secular bear trend. In the 1966-1982 secular bear, the absolute low for the Dow was on December 6, 1974, when it reached 577.60. It took nearly nine years to reach that absolute price bottom. What followed (the 7-1/2 year period from 1975-August 1982) was difficult, but we never saw lower prices than December 6, 1974.
David EC: An excellent point. The last secular (long-term) bear market occurred over a 16-1/2 year period of time which lasted from 1966 all the way through August of 1982. During this secular trend, there were four mini-bull markets, or "cyclical" bull markets as many like to refer to them which were of a shorter duration.
Bill: The 1929-1949 secular bear market was more challenging because we clearly saw very low prices after the crash of 1937 and again in April 1942, just five months after Pearl Harbor. I have seen a number of market historians refer to the secular bear trend of 1929-1942; however, my understanding is the environment was so unstable from 1942-1949 that most people didn't want to own securities during those seven years. The war and the Great Depression were still on the minds of Americans (the A-bomb was dropped on Japan in August 1945.) It was clearly difficult to be an optimist during those seven years. What made the 1929-1949 secular bear unique is the ultimate price bottom was in July 1932, but I don't think anyone believes a new bull market began in 1932.
David EC: There were arguably four cyclical bear markets and three cyclical bull markets during the 1929-1949 secular bear market. Here is a link to an analysis of those cyclical markets within the 1929-1949 secular bear:
The Bubble Bursts - Secular Bear Chart 1929-1949
Bill: Fast forward to today. The current secular bear market trend began in March 2000 so if the March 9th price low holds, the peak in prices (with some fudge factor of a few percent) to the trough in prices will be nine years, just like the 1966-1982 secular bear reached it¹s trough after nine years. We already had financial Armageddon. We already had the bursting of the bubble(s) and are again in the rebuilding stage. Yes there are perma-bears like David Tice (Federated Prudent Bear fund), Nouriel Roubini (Economist professor) and Peter Schiff who are certain we will see new lows in the future but I believe they will be proven wrong. If this secular trend turns out to be 16-17 years long like many of the others, then we have another 7-8 years of choppiness. It may make sense to study the seven year periods of 1942-1949 and 1975-1982 closely to see how people and the markets reacted after major lows. Those sideways trends may be a guide for the future.
David EC: That¹s a great idea and it is moving to the top of the DavidK topic list.
Bill: The critical point to this discussion is that ANY pullback in prices for whatever reason should be viewed as a buying opportunity for any long term investor.
Returns by Decade
It is very rare to have a decade when the stock market loses money but we will most certainly see that at the end of this year. According to Ibbotson Associates (acquired by Morningstar), the following list is the return on Large Company Stocks (think S&P 500) by decade
1930s: - 0.1%
1940s: + 9.2%
1950s: + 19.4%
1960s: + 7.8%
Note that the 1970s number is an anomaly because inflation was much higher during that decade than others. The 7.4% inflation rate brought the real rate of return to negative for the decade of the 1970s. According to Standard & Poor¹s, for the 10-year period ending June 30, 2009, the S&P 500 has shown a LOSS of 2.221% compound annual return. That is unlikely to change significantly in the next 4-1/2 months which means this will be worse than the decade of the 1930s.
What is instructive is that after a bad decade (1930s & 1970s), it is common for the next 10 years to be better than normal. Another long-term bear that turned positive early this year is Jeremy Grantham. His seven year forecast at the beginning of this year was for large company stocks to average 8.9% per year for each of the next seven years. While that¹s not a decade, it does confirm the "return by decade" phenomenon.
David EC: Jeremy Grantham oversees almost $100 billion for GMO, an institutional money-management firm. Grantham was out warning of the global financial meltdown in 2007, a time when many others were claiming a new secular bull market. Grantham said he thought a fair price for the S&P 500 was 900 and he bought back into the market in March by sheer divine intervention getting near the lows. He also said he thinks is is likely, but far from certain, that we go back and make a new low. Smartmoney published an article a few months ago entitled, "Why Jeremy Grantham Changed His Mind" which you can access at this url:
Smart Money: Why Jeremy Grantham Changed his Mind
Active Money Managers
Recently Bob Brinker has been touting how well his "Portfolio I" and "Portfolio II" have been doing and the fact that they are outperforming the active/passive portfolios and the S&P 500 Index. Because everyone has an axe to grind (me included) I will fill in the blanks. The reason Bob's portfolio is doing better than the active/passive portfolio is the funds he holds that have managers making decisions have been able to find incredible bargains over the past 6-9 months. There really are smart investment managers out there who do consistently beat "the market" over time...you simply need to do the work and find them. Bob's "Portfolio I" owns the same holdings as it did in 2005 so he doesn't make changes very frequently.
Bill: As a bonus to last year's market rout, many mutual funds have significant capital loss carry-forwards on their books. That means these funds can trade around positions, take short term gains without passing gains off to shareholders and make moves to benefit shareholders. That is not true of the Vanguard S&P 500 Index or the Vanguard Total Stock Market Index Fund. Bob will not mention this because it doesn't fit his model. He talks about how tax efficient index funds are in a roaring up market, but he does not address that active managers can protect on the downside and offer better returns and tax benefits during difficult market periods. IF, and this is a big IF, we are in for a turbulent six or seven years (cyclical bull and bear trends), then these active managers should continue to have an edge over the index approach.
Distribution of Annual Returns.
Bill: On the July 25th show (and others) Bob Brinker has been stating that 2009 would be a "significant positive year for the market." To give you some perspective, the attached spreadsheet shows the total return of the markets from 1926-2008.
Bill: Below are some of my comments and interpretation of the data:
1. Through 12/31/08, the market has averaged 9.62%. It is common to hear that stocks tend to average around 10% per year "over the long term" but notice that we have been in the 8-12% range only five out of those 83 years. The message confirms what investors have been feeling which is the market tends to be up a lot and then down a lot.
2. The frequency of returns are skewed to the positive side as 71% of the time (59 years), the S&P 500 Index is positive and 29% of the time (24 years), the return is negative.
3. Notice where 2008 fits into this graph, far on the left hand side in the 20% loss or more column. I am assuming that we will work through the current problems and re-establish a growing economy. Ignoring 1930 and 1931 because the Depression scenario is off the table, let's study the returns following the other years when the market was really bad. After 1937, the market rallied 31.12% in 1938. Following the lows of 1974, we saw an increase of 27.23% in 1975. Finally, we all remember the bear market of 2002 and saw a 28.69% rally in 2003. How many people do you know are expecting gains in excess of 20% for 2009? Perhaps this history is part of Brinker's reasoning for a "significantly positive" year forecast.
When Will I Get My Money Back!!!
Bill: I think is human nature to remember the value of your brokerage statement at the highs. It is equally natural to wonder when you will get back to that level. While that level is totally arbitrary and may have nothing to do with your ultimate goal (for example, suppose you had $1 million which declined to $700K, but you really need $2 million to retire), the fact is there are actions you take that can improve your success rate. If you lost 30% last year, you will need a 43% return in one year to reach break-even. If you wait five years, you will only need a 7% return per year to get back to 12/31/2007 levels. However, adding to your portfolio every year can greatly shorten the time to reach break even. For example, if you started with $500,000, lost 30% but added $10,000 per year, you would only need a 4.8% return to reach break even in five years. The link below will allow you to input your own numbers to see how quickly you may be able to get to your high water mark:
Kiplingers Calculator: Recoup Your Losses
David EC: The historic Dow Jones Industrial Average is still down 34% from its all-time high recorded in October 2007 of 14,164.53.
The Only Market Timing Indicator You Need (well, maybe not)
Bill: Instead of monitoring market valuation, reams of continually changing economic data, monetary policy, investor sentiment, technical analysis, historical trends, Presidential cycles, and a myriad of other information, how would you like one data point that would have told you when to get out and when to get back in? What if there was an indicator that reached its peak in March 2000 (the market highs) and turned down, then turned up in June 2003 (a few months late) but generally stayed positive until its peak in September 2007 and experienced a meaningful decline in 2007 (which happened to again be the peak for the S&P 500). This indicator continued down to lows not seen since 1995 but turned positive in January 2009. Again, this was not the bottom, but I haven't found any market timers who
have successfully captured these major turns. What's the indicator?
Drum roll please David...
The Manheim Used Vehicle Index.
David EC: It is intriguing. Manheim uses statistical analysis to more than 5 million used vehicle transactions annually to come up with a measurement of used vehicles prices that is independent of underlying shifts in the characteristics of the vehicles being sold. Link to their report follows:
Manheim Used Vehicle Value Index
Bill: Like the price of butter in Bangladesh, this might be one of those coincidental indicators, but it's worth adding to the Economic part of the model and checking periodically.
David EC: I agree. Manheim publishes their index monthly. According to their web site, wholesale used vehicle prices rose for the seventh consecutive month in July. The Manheim Used Vehicle Index for July was 115.4, an increase of 5.0% from a year ago. Manheim says that "although the cash for clunkers and resulting revitalization of new vehicle sales stole all the headlines in July, used vehicle retail activity remained solid and higher residuals and recovery rates boosted the earnings of lenders and lessors. And, despite having to pay higher prices for inventory, dealers have seen an improvement in used vehicle retail gross margins."
Miscellaneous Market Comments
Technical Analysis: The stock market rally since early July has that "hockey stick" look to it and that normally corrects itself. It doesn't matter if it's oil, soybeans, stocks, interest rates or the price of timber, whenever we see a steep uptrend like this, it is unusual for it to continue. The correction from mid-June to July 10th was only 7.08%. Historically, the time from mid-July through September is a difficult period for stocks. Given the number of investors who are still kicking themselves for not getting back in, it's possible that any correction could be one of time rather than price.
Standing back and looking at the weekly chart of the S&P 500 over the past few years, we have an "Inverse Head & Shoulders." The left shoulder is the action from last October/November; the head is the March 2009 action and the slight pullback in June/July is the right shoulder. The calculation takes the S&P 500 to the 1250 area.
David EC: Bill is referring to various chart patterns which technicians use to try and forecast the market. There are many resources to learning about these types of technical indicators. Here is a link to a good one:
Bill: On August 6, Abby Joseph Cohen said she expects the S&P 500 to earn $75 next year. Attaching a multiple of 16 times to that estimate takes the S&P 500 to 1200 or about 25% from its current level. She also said that many of the bad performing companies in the S&P 500 last year (think Lehman, Bear Stearns) are no longer in that index and therefore the index has the potential to go even higher. Year-over-year earnings in the fourth quarter should be explosive; the question is, does the market know that and is that being priced into securities today.
David EC: The Wall Street Journal just published an article entitled, "After Dow's 42% Run, Roadblock¹s Looming" (thanks for the link Tony) which you can access at this url:
WSJ: After Dow's 42% Run, Roadblocks Looming
Bill: Everyone seems to be worried about inflation these days because of recent monetary policy and deficit spending. I am confident that Bernanke will fight inflation when the time comes, but I find it curious that investors will worry about this threat 2, 3 & 5 years down the road but won't look at the fact that we have a non-existent energy policy. This lack of an energy policy is what investors should be worried about in the coming years. As an aside, remember when Warren Buffet was berated for buying Goldman Sachs with warrants in the $116/share range as the stock declined below $100 (and ultimately down to the $50s). He is getting the last laugh as it currently trades above $160! Conoco Phillips is one of his top holdings and it hasn't moved very far off its bottom. Maybe instead of worrying about inflation in 2-3-5 years, one should take a long-term look at an energy company like this one.
Bill: Without a doubt, this country has issues to deal with including the "spending like drunk sailors" in Congress that Bob talks about. With California issuing IOUs to pay bills and cutting many many services, I wonder if this will become reality in cities across the country. During the July 4th celebrations, I recall seeing citizens interviewed by the local TV
reporter and saying, "I can't believe they cut out the fireworks this year. It's just not right!" Newsflash. If cutting out fireworks totally upsets citizens, I think some people may be in for a big surprise when essential services like garbage collection, police and fire departments and even library hours get cut.
EC: Add this to the mix: California's two biggest government pension funds had lost close to a $100 billion in the fiscal year ending June 2009. CalPERS' preliminary losses were $56.2 billion while the California State Teachers' Retirement System lost $43.4 billion. The numbers are staggering.
Bill: Like Brinker, I am EXTREMELY concerned that President Obama has not appointed Ben Bernanke for another term. If Larry Summers becomes the new Fed Chairman, the position will have shifted from independent to political and we will have someone in office that may not fight inflation the way Bernanke would. This could be the reason for a correction in the upcoming months.
David EC: Read the article, "Bernanke in the Cross-Hairs" at this url:
WSJ: Bernanke in the Crosshairs
Bill: We will continue to have problems whether they be economic growth, inflation, monetary policy, consumer spending, employment or political. In a long term bull market, you go from having ALL PROBLEMS to having NO PROBLEMS. In 2000, we had peace and prosperity and ended up with an Armageddon scenario with September 11th, corporate scandals and into the invasion of Iraq in early 2003. If we eliminate all of the problems quickly, we will have a shorter bull market. If it takes many many years to solve these problems, we will have a much longer bull market. This is the "wall of worry" argument. It bears noting that to wish for the volatility of equity securities to go away, is to wish for their long-term higher return to go away. Investors are rewarded over the long term for enduring the volatility in stocks.
David Korn's Stock Market Commentary, Interpretation of Moneytalk (Bob Brinker Host), Financial Education, Helpful Links, Guest Editorials, and Special Alert E-Mail Service. Copyright David Korn, L.L.C. 2009
Honeybee here: You can request a free issue of David's weekly newsletter as described above and you can download a free issue of David's Retirement Advisor Fixed Income newsletter that he co-edits along with Kirk Lindstrom here: [LINK]
Honey's Weekly Market Reports:
* Nasdaq Composite Index closed at 2020.96, gaining 1.8%.
* S&P 500 Index closed at 1026.13. gaining 2.2%.
* GLD closed Friday at $93.65.
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