2010: The Tragic Year
By Paul Lamont
January 31, 2010
“’What he really needs now is a recovery strategy. Statistically, it's been proven that big lottery winners wind up poor in a relatively short time unless they took the annuity payment,’ said financial analyst Brian Kronenberger, who has worked with a number of lottery winners.”
From investors to central bankers, desperate market participants are all betting on a recovery from the near-Depression. With the market selling off sharply from an exuberant secondary high, it appears history will unfortunately repeat.
This is the tragic year where it will become obvious that a Depression is at hand.
Stock Market Expectations
In November 1999, Warren Buffett who “almost never talks about the general level of stock prices” discussed long term stock market valuations. As he explained, “to get some historical perspective, let's look back at the 34 years before this one--and here we are going to see an almost Biblical kind of symmetry, in the sense of lean years and fat years--to observe what happened in the stock market.”
Back in April of 2007 and again in February of 2009, we alluded to these significant turning points in long term market expectations. Since this expectation cycle happens over a span of roughly 32-40 years, very few investors (if any) have experienced the full revolution. One must therefore learn from the past.
Ebb and Flow
Robert Sobel in The Big Board: A History of the New York Stock Market relates the ‘round-trip’ of the Great Depression:
“The psychological effects of the 1923-1929 rise were major factors in the boom, bringing optimism to shareholders and observers alike. The 1929-1933 toboggan had an opposite effect, and helped make the thirties a decade of fear. While he had been “making money on the stock market” in the twenties, the investor would have felt justified in buying goods on time, in living beyond his income, and in discounting tomorrow. The disillusioned investor of 1932 lived as frugally as was possible, turned his back on the heroes of the previous decade, lost faith in the present, and saw little hope for the future. If the upward swing took investors to the clouds, the downward turn brought many to the depths. Similar stories could be told of other investors, who took the ‘round trip’ of 1923-1933 with other securities (see Table 13.8).”
While we prefer the Q ratio, the cyclically adjusted price to earning ratio from Robert Shiller (shown below) accurately reflects the full cycle of stock market expectations. If the market “took investors to the clouds” in 1929, stockholders back in 2000 entered the ionosphere. It should be of no surprise that since that time investors have been continually disappointed.
Panic But Not Rock Bottom
We would argue that valuations did not become cheap enough in 2008 to register a long term bottom. In 1970, Adam Smith (pen name of George J.W. Goodman) in Supermoney describes the market atmosphere during the lows of the 1940s;
“A generation ago, it used to be the other way around. There were far fewer stockholders, and the stockholders were much more likely to know the business, perhaps even control it and hence to know the auditors. Management liked to pile up cash, a reserve against leaner years. They did not want to report income. The stock market was sleepy; besides, the stock market valued assets and dividends, not reported income. If you reported big profits, your unions would ask for more money. The tax man would ask for money. Your shareholders would expect a bigger dividend.”
Historically, public interest must be driven from the stock market before valuations become truly cheap. This can happen in a multitude of ways, but we suspect it will be a combination of losses and lack of funds to invest. Most investors will finally become skeptical of the Wall Street selling machine like generations before. Only then will investors find real bargains in a sleepy stock market. At that point, high dividends (generally from 7-20%) will also allow retirees to ignore price fluctuations and earn a comfortable dividend throughout retirement. Just as a reminder, we expect the Dow Jones Industrial Average to be around the 3k level by 2012.
“This talk of 17-year periods makes me think--incongruously, I admit--of 17-year locusts. What could a current brood of these critters, scheduled to take flight in 2016, expect to encounter? I see them entering a world in which the public is less euphoric about stocks than it is now. Naturally, investors will be feeling disappointment--but only because they started out expecting too much.” – Warren Buffett in Fortune, 1999.
When Expectations Fall
“For the record, I must make a correction to the statement that all investment trusts looked like monkeys at the time of the boom and crash. Once upon a time there were two small trusts, managed by the late John W. Pope, which were of such stuff dreams are made on. To be exact, the time was that impossible period in finance, 1929-1931. Everything about these companies was the opposite of all other trusts, including the fact that they made big money while the others were losing big money. Everything about the intellect and philosophy of the youthful Mr. Pope was the reverse of what I have explained a Wall Streeter must be. His statement of condition as of Dec. 31, 1930, was extremely simple. All the money was in cash and call loans, which, strangely enough, was precisely where it should have been. This statement also contained an incredible sentiment (I quote from memory), to this effect:
‘It is the belief of the management of this corporation that a diversified list of carefully selected securities, held over a period of time, will not increase in value.’ (The italicized word is mine.)
His record of performance was even more startling than his principles. Frequently his trusts had only a single large position, and that would be on the short side. (Nearly all other investment trusts forbid themselves ever to take a short position.) During these periods, of course, the profits showered down, month by month, and even day by day.” – Where Are the Customers’ Yachts? Or A Good Hard Look At Wall Street by Fred Schwed, Jr. 1940.
Progress Thus Far Part 2
For those who are not willing to short the market, we also protect principal with U.S. Treasury Bills, the purest form of cash. Our expectations are displayed in our updated Great Comparison Chart presented last June.
As the chart above states, we expect the sharp sell-off over the next few months to develop into a crash this summer. In the meantime, we expect the U.S. dollar to continue its uptrend. Things should heat up as European countries continue to experience tougher credit conditions. As expected, wild spending from politicians usher in the next wave of crisis. Losses in weaker countries will spread into the stronger nations through the global banking system. As detailed in Global Margin Call, individual investors who in the last few months were wiring their funds to far off lands have arrived just in time to experience maximum losses.
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***No graph, chart, formula or other device offered can in and of itself be used to make trading decisions. This newsletter should not be construed as personal investment advice. It is for informational purposes only.
Copyright ©2010 Lamont Trading Advisors, Inc. Paul J. Lamont is President of Lamont Trading Advisors, Inc., a registered investment advisor in the State of Alabama. Persons in states outside of Alabama should be aware that we are relying on de minimis contact rules within their respective home state. For more information about our firm visit www.LTAdvisors.net, or to receive a copy of our disclosure form ADV, please email us at firstname.lastname@example.org, or call (256) 850-4161.