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I.I.
Unfortunately, I can't give you too many
details, not only because of the
proprietary nature of the topic, but also,
because of the time that it would take to
get into all the details. However, we can
keep it simple by saying this: I use 12
indicators to gauge the markets, most
of which we will cover shortly, in part 2.
I have designed a "Composite"
indicator which is made up of the weighted
average sum of those indicators. I can
increase, or, decrease the weight factor
from time to time, in order to emphasize a
specific aspect of the market (although we
do it rarely, in order to maintain
continuity) We calculate the Composite
daily, then we feed the daily readings of
the Composite for the last 15 trading days
(we can change that too, if we want) to
the computer, and we ask the program to
find any 15 day period in the last
15 years with at least 10 identical daily
values . Once the program identifies the
periods, then it examines the price
action over the next 30 days, or, 45
trading days. Let's say in the past 15
years, we had five 15 day periods with
similar readings, and in three out of
those five periods the market rose on
average 6% within 30 days, and it fell in
the other two on average 4% within 30
days. Then we will conclude that over the
next 30 days there is a 60% probability
that the market will rise 6%, and a 40%
probability that the market will fall by
4%. That's as simple as I can
explain it. The indicators that go
into the Composite cover a wide variety of
market aspects The fact that we are
getting "neutral" signals it
means that the market is not generating
"correlated action" among asset
classes, and sectors, that historically
are positively correlated with each other.
My good friend Dr. Hussman refers to a
similar concept as
"trend uniformity." At the
present time, many individual components
that make up the market, are moving almost
in a random manner, or, in a
"vacuum." Markets that lack
uniformity, are market whose risk is above
average, and potential returns are below
average. Therefore, from a "return to
risk ratio" point of view, they are
unattractive. This month the model is
still giving us a neutral signal, but the
price targets are quite shocking,
we'll get into the details when we get to
that part. For now I can say this: market
conditions still remain unfavorable
for unhedged portfolios.
D.B.
Very well, let's get into the long-term
stuff you want to talk about.
I.I.
The market's action lately has unnerved
many investors -as evidenced by the
e-mails that we have been getting lately.
Many investors are thinking of their
portfolios as long-term investments, but
they are beginning to feel that the future
holds something totally different than
what they are accustomed to. So, I'll try
to share my views about the future with
regards to the stock market, and the
things that investors need to be aware of.
First
of all, investors need to understand the
factors that were at work in the 90s, and
how they affected market returns, and the
economy. Second we need to examine, if the
same factors are still present. If they
are not, they can not possibly impact the
market.
1.
In the 90s we saw a tremendous boost in
consumption, which fueled the economy, and
contributed mightily to the growth of GDP.
That tremendous boost in consumption was
caused mainly by the baby boomers -70 some
million of them- who were between the age
35-45 during the 90s, many of them
at/or near the peak of their
earning power, well educated,
enjoying two income households, still
healthy, and with kids at least 10 years
away from college. Baby boomers had
more disposable income in their hands than
any other previous generation, and they
enjoyed spending it. They also discovered
the stock market, and invested in it,
believing that their investments will pay
for their kids' education, and will enable
them to retire comfortably. In the late
90s the outsized market gains, not only
allowed baby boomers to continue their
spending unabated -because they saw no
need to increase their savings as they
were getting older, and market gains
allowed them to buy even more stuff, that
if it was not for the capital gains they
would have never bought them. So,
profligate spending by baby boomers had a
lot to do with the economy's growth in the
90s, and the growth in corporate profits.
However,
in the next 10 years this factor won't be
present boosting the economy. First of
all, many baby boomers have seen their
investment portfolios shrink. They have
seen their kids' college account shrink,
at the same time their kids are either in
college, or, one to two years away. That
means they now have to pay college
tuition fees for their kids, and in all
likelihood the college account they
started a few years ago, is now worth less
than what it was worth just 2 years ago,
and it is not enough to cover the college
expenses. That means a) baby boomers not
only can't afford to put more money into
the market, they now have to take money
out of the market in order to meet their
obligations b) since their investments did
not grow as they had expected they now
need to save more, in order to make up the
shortfall in the funds needed for the
kids' college, in other words,
they have less disposable income c) not
only they need to save more in order to be
able to cover the college tuition,
they also need to save more for their
retirement which is only 7-10 years away,
because those retirement accounts stuffed
with AOL, JNPR, NOK, AMAT etc, are down
about 40% with no signs of improvement.
Last but not least, they have to cope with
medical bills as they get older, plus some
of them have to care for their parents. In
summary, baby boomers, the
greatest consumers ever lived, who
fueled economic growth thru their
endless spending, will not be able to
maintain the same level of consumption
over the next 10 years. Less consumption
by group of the population as big as the
baby boomer group, will result by at least
1% reduction in GDP growth over the next
decade (by my estimates)
2.
In the 90s as a nation we enjoyed the
benefits of the piece dividend after the
end of the cold war. The end of the cold
war allowed us to re-deploy scarce capital
in more productive areas which resulted in
additional innovation, and job growth.
Productive employment of resources
produces superior returns. War re-deploys
capital from productive investments to non
productive investments, thus depressing
the long term returns on investment. So,
from a "macro" point of view, if
indeed the US is going to be
involved in a long protracted war, the
aggregate returns on the economy -and
those of the stock market- must be
adjusted down.
3.
During the late 90s we experienced budget
surpluses. The surpluses reduced the
government's gargantuan needs for
debt, thus putting a downward pressure on
long-term interest rates, which reduced
financing costs for every corporation,
which resulted in higher profits, higher
capital spending, and more employment. It
also reduced financing costs for
every American, making it easier to afford
a loan, and thus making easier to buy
things on credit, which again boosted
consumption. That era is gone. We are
going to see deficits in excess of 100
billion a year at least for the next five
years. The return of budget deficits and
the loss of the economic benefits that I
just explained, will further reduce future
economic growth.
4.
In 1995 Secretary Rubin embarked on a
"Strong Dollar" policy, which
adversely impacted our exports, and the
people who made a living from them, but it
attracted enormous foreign investment in
both tangible and financial assets.
The impact was profound in the area of
financial assets. Foreigners invested
billions upon billions in U.S. helping to
push equity prices higher, while enjoying
double returns, from the appreciation of
the dollar, and from the appreciation in
U.S. financial assets. The strong dollar
also helped to reduce interest rates,
because foreigners were willing to accept
lower interest rates, due to the
appreciation of the dollar, which more
than made up for the lower coupon payment.
More over, foreigners' involvement in the
U.S. debt markets, resulted in higher
availability of mortgage loans, which in
turned has fueled the housing boom. Most
people do not know, but about half of
Fannie May's debt is held by foreigners.
However, for the past two years investing
in the U.S. has been generally a losing
proposition. Now the dollar has
weakened as well, which means the double
returns foreigners got in the 90s, are now
being replaced by double losses, leaving
foreign investors with no choice but to
trim their U.S. holdings. Therefore, over
the next few years we will not enjoy the
benefits we had in the 90s due to the
strong dollar. We will see much fewer
inflows into equities, and higher interest
rates to compensate for a weakening
dollar. Such development, not only will
impact the return on equities, but also it
will further reduce economic growth due to
lesser availability of capital, and higher
interest rates.
5.
The burst of the NASDAQ bubble has
resulted in 3 trillion dollars of lost
wealth. We wasted scarce capital which can
never be recovered, resulting in having
available 3 trillion dollars less for
productive investment in new and
innovative technologies, which would
create jobs and additional wealth.
Therefore,
for all the above reasons, I believe over
the next 5-8 years, the U.S. will
experience -on average- a modest rate of
economic growth. Modest economic growth
will result in modest corporate earnings,
which in turn will result in modest market
returns, perhaps between 7% and 8%.
In
conclusion, investors need to realize that
many of the factors responsible for the
high economic growth, and above average
market returns, are no longer present.
Thus, even if the economy turned around
tomorrow, even if a new bull market was
born tomorrow, things will not be the
same. Therefore, in setting long-term
investment goals, investors need to start
earlier, save more, and create other
alternatives. |
AEGEANCAPITAL
GROUP INC.
