DJIA Forecast - The Long View
By Paul Lamont
August 20th, 2012
A secular bear market started in the year 2000. This is confirmed by the inflation-adjusted Dow Jones Industrial Average, dividend yield, % of stocks held by households, cyclically adjusted P/E ratio and the Q ratio (among others). Since we have harped on the last two enough in previous reports, let’s take a look at the first three of these long term measures, the progress thus far and what it implies for the future.
As we first mentioned in April 2007’s DJIA Forecast, “when the effects of inflation have been extracted, the DJIA is much more cyclical than Wall Street promoters would care to admit. In optimistic peaks of 1834, 1906, 1929, and 1966 the DJIA subsequently moved to the bottom of the long term trend channel.” Expecting an “End of the Boom”, we continued:
“How will we fall? Most bears remember and fear the stagflation of the 1970s. However with debt levels currently high, inflation cannot be maintained for an extended length of time. Debtors would merely file for bankruptcy or foreclosure (as they have begun recently). Instead a deflationary spiral similar to 1929-1933 or 1834-1842 is likely.”
As forecast, the deflating financial crisis of 2007-9 is clearly evident in the chart below from Fred’s Intelligent Bear Site.
Reflecting on this indicator since 2000, one might notice that when the stock market has fallen, inflation also falls. And when the stock market rose (2002-2007 and 2009-11) inflation rose to reduce the returns of stocks. We think this shows how the availability of credit affects inflation. This is also truly a lose/lose situation for buy and hold stock investors.
For now, even with all the credit money that has been created since 2009, inflation appears to be rolling over again. Value will be taken from stock investors by an actual fall in the market and not an erosion of inflation as the market moves to the lower end of the channel in the next wave down. The low (between 3-5000) still beckons.
Below is a chart of the dividend yield of the S&P500 since 1928 from Tim Wood’s Cycles News and Views. Companies pay high dividends to encourage investors to buy stocks when prices are low. Alternatively, at stock market highs, investors rely on price appreciation instead of dividends. As you can see in 2000 (chart below), S&P500 companies only paid a 1% dividend. Investors still bought stocks hand over fist believing that stock prices would continue to grow to the sky. It hasn’t worked out. On the flip side, in 1982, 1974, 1949, 1942, 1938 and 1932 (all good times to buy stocks) the dividend yield for the S&P500 index was above 5%. Yet folks were too scared to buy. The current dividend yield is historically low at 1.9%. Clearly, we have a way to go before stocks become historically cheap.
A Note on Dividend Stocks
Described as “a place to hide, secure, and consistent,” dividends appear to be the latest Wall Street bait for retail investors. Here’s the problem. We don’t care what it is: when you overpay, you lose. Investors have bid up individual dividend stocks relative to the market more than at any time since the early 1960’s (chart below).
As stocks continue their secular bear market, we would not be surprised if dividend stocks lead the way lower. These might be great companies, but the trading bots of today’s market care not. Dividends can be cut and when they do, those companies will be sold in a flash. For example, when JC Penny cut its ~2% dividend, its stock fell 12% in one day. The stock is now down 40% off the highs of the year. There is also that pesky fiscal cliff. Unless the politicians can come together to put future generations in worse shape, dividend taxes will rise to pre-Clinton era ordinary income tax rates (15% to 39.6% for the highest bracket). As we stated in April 2008; “taxes are a good reason to sell.”
Everybody out of the water!
The following chart shows stocks and mutual funds as a % of household financial assets. Notice that households held the highest percentage of stocks at the highs of 1966 and 2000 and the lowest percentages at the lows in 1949 and 1981. This (of course) is the complete opposite of how an investor should be positioned.
After the last secular bear market top in 1966, investors increasingly sold stocks. Perhaps they realized that they had bought at too high of a price. Or maybe they ran out of money. Or they just lost interest. Regardless, the same thing has happened so far since 2000. We expect it will continue. Bear markets, flash crashes, institutional failures, manipulation fears, even conspiracy theories; all have and will continue to scare investors out of stocks.
When ‘everybody’ is out (and thus price is low), stock indices will finally be ready for a multi-year bull market.
So when we hear people say that ‘they will never invest in stocks ever again,’ that just means we are just getting closer to being able to buy at historic lows. But we aren’t there yet. Some are still day trading their 401ks.
Timing the Secular Bear
Independent of the secular bull/bear cycle, a coincidence that is truly hard to ignore is the repetition of significant sell-offs every 13 years: the Dot-com implosion of 2000, the Crash of 1987, even back to 1974 (previously mentioned in Bear Market Insanity). From there we can go back to the 30% correction (the 1987 of its day) of 1961-2. The Wall Street Journal has a great description of this ‘flash crash.’
If this coincidence continues, this implies some sort of crash or low in 2013. It’s interesting to note that a large majority of world stock markets did not make a new recovery high this year. They may already be working down to a low in 2013. Only Mexico, Indonesia, Malaysia, New Zealand, and select U.S. indexes continued to hold up into 2012.
United Kingdom 2011
Mexico New highs in 2012
Canada (Toronto) 2011
China (Shanghai) 2009
China (Hong Kong) 2010
Indonesia New highs in 2012
Malaysia New highs in 2012
New Zealand 2012
South Korea 2011
S&P500 New highs in 2012
Dow Jones Industrials New highs in 2012
Dow Jones Utilities New highs in 2012
Dow Jones Transports 2011
NASDAQ Composite New highs in 2012
NASDAQ 100 New highs in 2012
Fast Forward Through the Secular Bear
There are three markets mentioned above that have already experienced their secular bear market. In our next report, we will highlight these opportunities just as we did in Crash Opportunities Part One and Two in the last cycle.
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