NOTHING IS POSSIBLE

“WHO SAYS NOTHING IS IMPOSSIBLE?
SOME PEOPLE DO IT EVERY DAY!” MAD
MAGAZINE E.C, PUBLICATIONS INC.

The money flowing out of Washington is so large and has happened so fast, that only the tooth fairy understands what just happened. What we do know is that the mammoth infusions of fiat money is hyper-inflationary over the next five years, and probably does very little to “Put America Back on its Growth path”. The Euphoria over the election of the new President is about to come to an end. Our Congress and President have lost it.

The Stock Market which represents the best and brightest minds in America, and back their opinions with real cash, have voted on all the Politicians bail-out’s, and “Saving America Programs”, and have posted the following results from Election Day to 2/20/09: SP500 lost 26.70%, NASDAQ lost 21.12%, DOW 30 lost 26.76%, DOW Transportation Index lost -41.13% and the Wilshire 5000 lost 25.86%.

How do you like the vote by real people who invest real money? To add insult to injury, the loss in dollars, since election day (measured by the Wilshire Index, above), is $2.303 Trillion.

Since the peaks of the American stock market and housing, $8.05 Trillion has been lost in the stock market and $7.5 Trillion has been lost in housing. Investments in stocks and housing (since the peak in October 2007), have lost $15.5 Trillion. Globally, the estimated losses from the peak in stocks and housing are $30.0 Trillion for stocks and $ 30.0 in housing. A whopping $60.0 Trillion has been lost because of excessive liquidity and the expansion of irresponsible credit. You think that providing bee keepers with insurance will set the US Economy on fire?

We have a big problem. Yes, someday housing and stock prices will advance, but today, World investors are mad, and do not trust housing and stocks as an investment. It is my experience (since 1968) that investors are not quick to return to investment alternatives that buried them. Housing will again be a place to live and the Stock Market will be a trader’s arena, with the general public staying away.

The chart below indicates the ratio of Money to the market value of the Stock Market. The average ratio since December 1991 has been 54.07%. For the seven days ended 2/9/09, the ratio is 107.24%. Note that the Ratio rose over the average from 1/14/02 and peaked on 3/10/03 at 81.14. After the peak, money still exceeded the stock market and occasionally dipped under the market value of stocks but never got a major foothold. As a result the stock market has been rather boring on the upside and only recently got interesting with its crash. The possible good news is that there is a lot of liquidity standing around waiting for an opportunity in investing in something other than boring old cash.


Money in the chart above is MZM which is defined as: Currency in circulation plus demand deposits plus Large Time Deposits plus Term Repurchase Agreements minus small denomination time deposits plus Institutional Money Funds. The stock market value is defined as the Wilshire 5000 index.

Is the Stock Market today really cheap? In my opinion, no, and I’ll tell you why. Over the past 20 Years, the advent of individual retirement plans increased the demand for stocks exponentially. Add to it Hedge Funds, and other investors of OPM’s (other people’s money) and you had the perfect formula for a Bull Market. The supply did not keep up with the demand. New suppliers emerged (Mutual Funds, ETF’s etc) to accommodate the new demand, but the stock supply didn’t match up with the new demand. Since Mutual Funds and 401K Plans were “always” invested in the Stock Market, it was this set of players that created of one of the greatest bull markets in the History of America.

The Bull Market from November 1990 to August 2000 was the longest in history lasting 118 Months. The most current bull market was the third largest on record lasting 56 months from March 2003 to October 2007. The second longest Bull Market lasted 71 months from November 1923 to September 1929 (remember that one?). In the most current bull markets, most decisions were made by men that had never seen a market crash.
Due to the advancing prices, new theories of value emerged. The old school of value that said “buy good stocks that had a 5 to 12 PE multiple and a 4% to 6% dividend.” was dismissed as “out of touch”.

From the period December 1973 to October 1990, the average of the price earnings ratio and dividend yield for the SP 500 was 11.75 and 4.32% respectively. From November 1990 to December 2008 the PE and dividend yield on the SP 500 was 23.71 and 2.04%. The demand and supply increased to the point that everybody was invested one way or another in the stock market forcing up the PE and driving down the yields. Old school investors learned the hard way, that investing in stocks can be very risky. In the good old day’s stocks carried a risk premium.

At this writing the SP 500 closed at 770.05. Per share earnings estimates, for the years 2009 and 2010 are $41.88, and $51.48 and dividends per share estimates are $12.62 and $23.20. This results in a PE ratio for 2009 of 18.39 and 14.96 for 2010. The dividend yield for 2009 and 2010 would be 1.64% and 3.01%. This hardly represents a risk premium. To arrive at a historical “stocks are cheap” basis the S&P 500 would have to be at 617.76 to achieve a 12 times PE (2010 Earnings). On a yield basis, the SP based on 2010 dividend expectations would have to be at 464.00 to yield 5.00%. Using 2009 earnings and dividend estimates would make matters even worse.

I suspect that the earnings and dividend estimates for 2009 and 2010 are overstated, because historically analysis’s are slow to change their estimates (they work for the very people that are trying to have you buy stocks).

As a concept: buy stocks when they are cheap and sell when they are expensive is common sense. In his book “Irrational Exuberance” Robert J. Shiller (Professor of Economics at Yale University) did a study of returns on stock investments and showed that PE ratios and Dividends indicate to a great extent when stocks are cheap and when they are expensive. He says:

“…as a rule and on average, years with low price-earnings ratios have been followed by high returns and years with high price-earnings ratios have been followed by low or negative returns.” (Page 187 2nd Edition). And, “As a matter of historical fact, times when dividends have been low relative to stock prices have not tended to be followed by higher stock price increases in the subsequent five or ten years. Quite the contrary: times of low dividends relative to stock prices in the stock market as a whole tend to be followed by price decreases (or small-than-usual increases) over long horizons, and so returns have tended to take a double hit at such times, from both low dividend yields and price decreases. Thus the simple wisdom—that when one is not getting much in dividends relative to the prices one pays for stocks it is not a good time to buy stocks—turns out to have been right historically.” (Page 188 2nd Edition).


We need to watch two statistics that will determine the investment strategy for the next 2 to 5 years. The first relationship that bears watching is the ratio of Gold Prices divided by 10 Year Bond Prices. In determining the war of Inflation/Deflation, Gold and 10 Year Bond Prices should de-couple. Currently, both Gold and 10 Year T-Bonds Prices have been going up together. For Deflation to be the winner, the ratio above should start going down. If Inflation is the winner, the ratio should be going up. Note the chart above indicates, the Ratio is going up, which translates to a brief victory for Inflation.

The 2nd thing that you have to pay attention to is the yield to the Chinese in investing in US Bonds. The above chart reflects what the Chinese yields are in Yuan, in investing in 10 Year US T-Bonds for a holding period of 1 year (including interest).
Note the yield for the year ended 2/20/09 is 7.70%. However, the yield is declining. The significance of this chart is, that if the Chinese start losing money on owning US Treasuries, they will be inclined to sell these Bonds, which would drive T-Bond yields higher, and contribute to an Inflationary expectation.

I continue to advocate buying Gold on dips (10% to 20%), and short term Cash Instruments such as T-Bills, and Federally Insured CD’s. The stabilization of the World Economies will take a long time (2 years or more), and in the interim, stay liquid, out of debt, and own some Gold.