This is a watch out situation in the making. Depending on how (and of course if) it is done it sets up for unintended consequences. If policies and procedures are antiquated I am all for making changes but this seems like a reaction to a crisis which would end up catering too much to the things that caused the crisis as opposed to long term changes that could generally make the agencies better/more relevant/more able to fulfill their primary mandate.
From the good doctor, Hussman that is...
Investors will likely be reminded of how the market has historically performed following two consecutive cuts in the Discount Rate. We've observed 11 instances of this since 1950, with average total returns in the S&P 500 of 6.18% over the following 3 months, 12.48% over the following 6 months, and 21.05% over the following year. The difficulty with these averages is that the cuts almost invariably occurred well into bear markets, where valuations were already depressed.
Rate cuts strikes me as the sort of thing that is subject spin and data mining. Also it is the type of truism (rate cuts=higher equity prices) that can do the opposite of what it "should." If this snapback ends up being a 30% rally over the course of the next year I'd be thrilled to leave 3 or 4% of that on the table being cautious.
Lastly some of the big bad immediate threats to the market seem to have come and gone without real incident. The First Data deal looks like it is going to happen and commercial paper seems to be rolling, for the most part.
One of the biggies still floating out there is the impact of the mortgage resets that have been underway for a while and will be getting bigger every month for the next few months before they start to get smaller again.
The commercial paper thing turned out to be much smaller than some feared and I believe the mortgage reset issue will also be much smaller. It could cause problems but the sky will not fall. The likely worst case scenario is something well within historical norms that will soon be forgotten, like the early 1990s recession.
Stock prices cut in half (or worse) during the great depression, the 1970s and at the start of this decade. I believe there were earlier instances but my knowledge of history only knows when a couple of the older bad times were (the first decade of the 20th century, the 1870s and the 1830s I believe) not the magnitude of them.
It just doesn't happen that often. The reason for this, I believe, is behavioral. Most investors today know the fear of a market cutting in half because it just happened. Enough time needs to pass so that new participants who did not experience a 50% dive first hand can make the same mistakes (albeit with slightly different details) than past generations made.
17 comments:
Roger
A couple of minor points. Market was cut in half (more or less) in 2000-2002 tech wreck, as well as 1973-1974 blow up. I believe the peak-trough loss in Great Depression was more like 85%. Also, I seem to remember that in process of losing 85%, Dow actually was cut in half, recovered most of the losses, then plunged again, ultimately grinding to lowest point in mid-1930s. Someone better steeped in the history can correct me if I got that wrong.
The point was that although recency usually precludes repeated big downturns, there is precedence for it happening. Also, I would argue that current valuations leaves plenty of room for a 50%+ downturn (I recognize this point is debatable, but that's a separate discussion), and we can all think of many catalysts that could push us there. To be clear I'm not predicting, and probability may well be low. But it's incumbent on us all to observe that the potential exists and we should think hard now about what that might mean for us if we're playing this game.
Trying to work up a plan when the bullets start flying is likely to end in tears. Just my $0.02.
Michael
the dow did not quite come back before plunging again according to stock traders almanac. it peaked in 1929 at 381. dropped to 41 in 1932. snapped back to 194 in 1937 and then fell to 98 in 1938. it retraced a lot but no where close to where it was but maybe that is what you meant....fair enough.
I view that as one event, much like the multiple 20% declines were part of one event from 2000-2002 but maybe that is not the right way to think of it?
I think you give more chance for cutting in half soon than i do, maybe the trade is to buy whiskey, gun powder and jerkey, humor attempt.
If I were to guess on a future big drop I would account for the Fed printing money like crazy. In other words the drop might only be 20 to 25% in dollar terms but 50% if you look at the ratio of the Dow to gold.
I'm not in the "this time it's different camp", but one key difference between now and the other bear markets is obscenely high valuations. Right now, the P/E on the S&P 500 is at historical norms (around 16, I believe). I know for certain it was double that or more for the 29 and 2000 crashes. I'm not mortgaging the house to buy stocks right now and I certainly don't think a deep correction is ever out of the question, but the fact that valuations are relatively normal is something worth noting.
John Hussman would say that peak earnings means we do not have "normal" valuations.
My own casual observation is to believe that PE ratios have no predictive power for the broad market. PEs were very high for a long time before the market cracked in 2000.
I've said it before and I'll say it again. Until people have jobs they will keep spending, which will keep the economy afloat.
Roger
Thanks for straightening me out on the history. No canned goods or firearms, but I do own gold and commodities(GSG). :)
A while back I used Shiller's data (more than 100 years) to look at PE as a forward predictor of stock price change. A scatter plot of trailing PE versus perspective performance looks pretty random on any time frame from 1 to 10 years.
It's possible you could improve this using forward forecast earnings, but I didn't have that data (forward actual earnings would not be available so not valid to test). I suspect it would actually introduce more noise due to the forecast/actual tracking error, but no way to know.
On the other hand, if you normalize the earnings some useful forecast data falls out. I did an exponential regression of earnings versus time to use a sort of "trend earnings" number. Or you should get the same effect using Shiller's or Graham/Dodd simple moving average, e.g. average the earning of trailing 10 years. Idea is to filter out the short term business cycle variation on earnings.
Normalize earnings versus forward 1 year price change still looks like a random scatter plot. But at about 3 years it starts to look like a trend (i.e. higher starting PE results in lower forward returns) and by 5 years you get a pretty clear trend, improving as long term projection extends.
On that basis the forward 10 year price change projection of S&P 500 is in the ballpark of zero.
Of course 10 years is a long time and price could go a lot higher without invalidating the relationship, but I figure the potential for some big downside in next few years is higher than average, and certainly higher than generally perceived and therefore not priced into the risk premium. So I'm cautious.
I read your blog because you do a great job stressing moderation and balance. And regardless of an individual's personal risk preference, the core message applies. Keep it up.
The market is barely up any since 2000. I expect the Dow to break 20k before it hits 10k. Too many of you are bearish and expect a huge decline. The fact is the US markets have barely moved compared to international. We have a long way to go and I expect most of you will sit on the sidelines in fear.
I am 20% cash/80% equity and bullish near term.
lol, I think of myself as somewhat bearish and am about 80% in.
Naz is up .41% yet the QID is down 2.94%...what the hell is up with that?
If by Naz you mean the Nasdaq composite, you should know the QID tracks double the inverse of the Nasdaq 100.
Secondly taking two quotes in the middle of the day is not really the best measure. To the extent you care I would tell you to look at the historical price page of both on Yahoo finance. It will not be perfect. If you think it is too far apart then you should leave it alone.
Value ETF's
Hey Roger
Hope all is well with you.
Do you know if there is anything out there which shows ETF's that may be oversold or undervalued. For example, maybe someone may think that REIT ETF's are undervalued. Do you ever go looking for undervalued sectors or ETF's?
Thanks
Andy, i think seeking alpha syndicates that info from someone. That doesn't really fit in with what i try to do, at least i don't think it does?
The market is setting up for the big fall.
Morningstar usually does an article or 2 on ETFs that are overvalued/undervalued at the end of each quarter.
They still believe, as do most people, that REITs are a looooong way from being undervalued.
It's healthy to study market history and understand the potential magnitude of losses. I agree with Michael; although the probability of a 50% downturn may be small you never know what will happen.
Tickersense.typepad.com has a current post on global etfs that are overbought or oversold.
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