When discussing thefinancial markets with fellow investors, I
am often asked, "What book has had the most impact on
yourinvesting philosophy?" Without hesitation, I answer, "Triumph
of the Optimists."
This 2002 book isn't a how-to on investing or trading. Rather,
it's a treatise on theinvestment returns over the entire 20th
century. The book has had a profound effect on the way I view
thestock market . This little-known book radically altered my
thinking from focusing exclusively on narrow short-term results
to a broad-based long-term view.
In other words, it has allowed me to see the forest rather
than just the trees. It is through this prism that I feel
confident in making this bold market prediction.
"Triumph of the Optimists" looks at 101 years of global
investment returns and teaches what is, to my thinking, the
correct way to measure returns over time. What I found most
profound is that from 1900 to 2000, interms of returns,stocks
thumpedbonds , and bonds beatcash . Remember, this is despite
sharp downdrafts across the board in worldwide markets.
Other interesting facts include the reality that value stocks
beatgrowth stocks from 1926 to 2000. In addition, in the U.S. and
U.K., reinvested dividends would account for close to half of the
total stocks' annualized returns.
However, the authors were very cautious in making predictions.
The book implies that the optimistswill not continue to triumph
in the 21st century, due to theequity risk premium . Clearly, the
authors did not foresee the booming stock market, financial
system breakdown and the massive intervention by the Federal
Reserve, which has acted as acatalyst to push stocks to
record-smashing heights thisyear .
Despite the authors' caution, their arguments turned me into a
super-bull on the stock market.
While this is my overriding market philosophy, I strongly
think the short-term top is in place in the U.S. stock market for
the rest of this year. This belief is not in conflict with my
overall long-termbullish nature.
As "Triumph of the Optimists" illustrates, markets never go
straight up forever. There are always declines and occasional
sharp drops during long-termbull markets.
These declines provide opportunities for savvy investors to
buy stocks at discounted prices and ride them towealth over the
longterm . I am not alone in my proclamation that stock growth
has come to a short-term end . StreetAuthority co-founder Paul
Tracy thinks we have entered a period known as the "dividend
decade" with all returns being attributed to dividends rather
than market growth.
When you consider that 50% of all stock market returns can be
attributed to dividends during the roaring 20th century, this
scenario isn't too hard to imagine. Here are my reasons for
proclaiming the market top is in place for at least the rest of
|1. The End Of "Easy Money "
As a result of the financial crisis,the Fed embarked on a
historicquantitative easing (QE) stimulus program to keep
the financial system afloat and jump-start theeconomy
Most recently, this program involved buying $85 billion
in bonds a month. While the results of this unprecedented
intervention have pushed the stock market to all-time
highs, the intervention cannot continue forever -- and it
appears that the end of easy money has been signaled.
On June 19, it was revealed that the Fed is considering
pruning the stimulus starting in September. Just this hint
sent the stock market sharply lower by more than 2%. Prior
to the Fed's hint, thebenchmark S&P 500 has given back
4.6% since its May 21 high-water mark due tospeculation of
the stimulus ending.
Now, the speculators have solid evidence of the Fed's
potential move. While the fear has diminished concerning
the end of quantitative easing, with the Dow Jones
Industrial Average bouncing back to its 50-day simplemoving
average at the start of the third quarter. Speculation
about the end of the Fed's open-ended easing policy should
continue to provide strong headwinds against a new high in
Even the International MonetaryFund is warning about
ending theQE measures, saying that a poorly planned or
abrupt exit could have "adverse global implications,
including a reversal ofcapital flows toemerging markets and
higher internationalfinancial market volatility." All
investors, particularly emerging-market investors, need to
be aware of these implications.
|2. The Volatility Is Spiking
TheCBOE VolatilityIndex (VIX ) has climbed 67% from its
72-month low in March. On June 20, the index spiked more
than 20% in one day alone.
The index is designed to measure the expected volatility in
the S&P 500 over the next 30 days. It is also called
the "fear index" because the higher the index moves, the
greater the fear of a pendingmarket correction .
|3. Rising Interest Rates
Interest rates have started climbing. There is little that
can stymie a bullish stock market as much as the fear of
interest rate increases. As the economy begins to
transition away from direct Fed intervention, interest
rates will most likely continue to climb, resulting in
adverse conditions for the stock market.
Pending second-quarter earnings warnings have outstripped
positive forecasts 6.5 to 1. This would be the mostbearish
ratio in the past 12 years. Weak corporate earnings
results, combined with the headwinds of the Fed likely
turning back on the spigot of easy money, may weigh heavily
on stocks as big-money players jockey to dump theirequity
|5. The Technical Picture
As you can see from the above daily chart of the Dow, the
price has formed a double top near the end of May and
plunged to the 50-day simple moving averagesupport line.
The Dow tried in vain to break higher, but the worries of
higher interest rates and Fed easing ending kept the yearly
May highs in place.
Finally, the Fed mentioned ending the QE measures, sending
the Dow sharply lower and breaking the long-term support
line at the 50-period moving average. The next solid
technicalsupport level is the 200-day simple moving
average, about 800 points lower.
Risks to Consider:
Although I think all the signals are pointing to a
significant market correction, anything can happen, so be
cautious in attempting to time the market top.
Action to Take -->
Market corrections create opportunities for investors to buy
quality stocks at bargain prices. In addition, it is critical to
remember that even during market corrections, there are
individual stocks and groups that continue to outperform. It is
possible toprofit on the short side of any decline, but shorting
is suitable only for investors who understand the risks involved.
It is important tonote that even if this pendingcorrection is
severe, history shows that we can expect new all-time highs
within the next decade.
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