A permabull is defined as somebody who is always upbeat about
the future direction of the stock market and the economy. Recently
I have been called a permabull by certain members of the media,
which may be true since March of 2009, but certainly not true over
the past 14 years. Recall, in September 1999 I wrote about the Dow
Theory "sell signal" that had occurred. Then there was the Dow
Theory "buy signal" of June 2003. Most important was the Dow Theory
"sell signal" that was registered on November 23, 2007. Obviously,
I am not a permabull. As my father used to tell me, "If you think
the markets are going up, be bullish. If you think they are going
down, be bearish. And, if you think the markets are going to go
sideways, be boorish."
Even over the past four and a half years there have been occasions
where I have suggested raising some cash when I thought a
meaningful decline was coming. That strategy worked in 2010, 2011,
and 2012, but this year I was adamant that "sell in May and go
away" was not going to play. However, I did wrong-footedly target
mid-July through mid-August for a meaningful decline to begin, but
corrected that "call" when Vladimir Putin pulled our president out
of his Syrian crisis. Yet my mantra ever since March 2009 has been,
"You can be cautious, but don't get bearish." So in response to the
"permabull" label, this morning I am going to discuss some of the
bearish divergences that have been developing in US markets
First is the divergence between the
(INDEXRUSSELL:RUT), which serves as a benchmark for small-cap US
stocks and which has been noticeably weaker than the
(INDEXSP:.INX). Since the RUT has been stronger than the overall
stock market all year, its recent weakness could potentially be a
Next is the attendant series of charts showing the divergences
between the SPX and a rise in interest rates in the high yield
complex, the decline in third and fourth quarter GDP estimates, the
collapse of forward earnings estimates for the S&P 500, and
most troubling, the collapse in Bloomberg's Economic Conditions
Index. Studying that chart, one observes how tight the correlation
between Bloomberg's index and the S&P 500 has been over the
past four years, until recently. In fact, in decades of monitoring
the Bloomberg Economic Conditions Index, I can't recall such a
divergence ever occurring. The implication is that business
conditions are slowing at a very rapid pace, but the equity markets
are ignoring that. Of course it could be as I have suggested in
that nobody is going to pay any attention to the economic data
until December because of the shutdown and the debt ceiling debate.
The next "bear boo" is the Shiller P/E ratio, which at 24.6 is 47%
above its historic mean level of 16.5. The implication is that the
S&P 500 is 47% overvalued. For reference one should know that
the Shiller P/E ratio's historic low was 4.8, and the historic high
was 44.2. The bears argue that valuation is making it very
dangerous to invest in US stocks, but they have been saying that
for more than four years. Here's how the Shiller P/E ratio is
1. Use the annual earnings of the S&P 500 companies over the
past 10 years.
2. Inflation-adjust those earnings using the CPI into today's
3. Average the adjusted values for E10.
4. The Shiller P/E equals the ratio of the price of the S&P 500
Index over E10.
My issue with the Shiller P/E ratio is that it assumes what has
happened over the last 10 years is going to happen again over the
next 10 years, and I just don't believe it. In the crash years of
2001 and 2008, the S&P's bottom up earnings came in at $38.85
and $49.51, respectively. I particularly remember the 2008 earnings
report because Wall Street's "best and brightest" strategists
magazine in December 2007, following the November Dow Theory "sell
signal," with their earnings prediction for 2008. Those guestimates
centered around $100 accompanied by price targets for the year of
roughly 1700. The S&P 500 ended 2008 at 903.25. Using a simple
P/E ratio leaves the SPX currently trading around 16.4x earnings
and at 14.5x next year's estimate of $121.20. Clearly, not as
expensive as the Shiller P/E measurement, and if the SPX trades at
16.4x next year's estimate, it suggests a price target of 1987.
Speaking to the bears' "debt worries," to me it is interesting that
the debt ceiling crisis came when the deficit is actually coming
down a lot faster than even the CBO thought could happen. That
decline is going a long way in improving the future outlook. While
the bears expect the economy to contract, I believe the capital
expenditure cycle that is about to begin will actually strengthen
the GDP figures in 2014. Moreover, with a stronger economy, and
continuing low interest rates under Janet Yellen, we should be able
to gradually reduce the deficit. Fortunately for the US, there is
demand for our bonds and we are the world's currency. So what other
questions are circling my desk?
Have I missed the bull market?
If this is the secular bull market I think it is, they tend to last
somewhere between 10 to 20 years, so no, you have not missed the
bull market. What do I do with my fixed income? IMO, the secular
bull market in fixed income ended in July of last year. Accordingly
you should be very careful with the fixed income portion of your
asset allocation. If you have to be in bonds I would move to the
short end of the yield curve.
Where should I invest now?
Ever since January I have said to decide how much money you want to
commit to US stocks. Then break that amount into four tranches and
invest the first tranche today. Subsequently, pick a future point
in time to commit the second tranche (say two months from now).
Continue with that plan until you are invested.
Which US stocks should I invest in?
I would stick with the large capitalization names that pay
Should I buy alternatives instead of fixed income?
The only fixed income I own is
Putnam's Diversified Income Trust
), which is geared for a higher interest rate environment. And yes,
there are some alternatives to fixed income, but they have a higher
degree of risk. Some of the ETFs playing to a diversified portfolio
of REITs or MLPs make sense to me. And the final question...
Does diversification work/forward looking?
I will quote the great investor Sir John Templeton: "The only
investor that doesn't need diversification, is the investor that is
right 100% of the time."
Call for This Week
Random thoughts: We spend 90% of our time on things that only have
a 10% impact, and 10% of our time on things on things that have a
90% impact. While teaching kids to drive, it becomes apparent that
the best way to get into an accident is to drive while looking into
the rearview mirror. Regrettably, that is what most investors do,
trying to catch the last investment trend. I know enough to know
what I don't know. The answer to nearly every question starts with,
"It depends!" Be careful of statistics because a man can drown in a
foot of water.
Current thoughts: The Dow has eclipsed the upper side of its
Bollinger Bands (read negatively), and although that has happened
three times this year, it is still a very rare event! While my
timing models suggest this week still has the potential for some
upside energy to test the recent highs, or maybe make a higher
high, beginning next week they suggest there is another downside
window opening. If we don't see a correction start next week, it
means that, like late last summer, the powers that be have again
been able to prevent the normal corrective process. If so, it
implies this cycle could stretch into year-end, where the markets
could finally stumble as they contemplate another government