Stock Market Signal Blog

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This Global Markets Perspective features forecasts for every major market in the world. Coverage includes all major world stock markets, global interest rates, international currencies, metals, energy, and social trends.  Extended until May 20/09.

It has been quite awhile since I last made comments here on the Stock Market Signal Blog, but you know, things have pretty much developed just the way we discussed them back in September/October of 2007. In those entries we warned that the bursting leveraged financial bubble would lead to recession, deflation and perhaps, depression. We reminded you it was the 20th anniversary of the 1987 market crash and implied that we were at another market top of historic proportions. Then we referred to Mr. Bernanke’s many economic challenges in terms of the children’s’ Bop the Gopher Game. As suggested, some of those turned into “dynamite” and sent the economy spinning. (Lehman, AIG).

So, what should we talk about now? Are there fewer gophers in the garden? Well I can remember when a Million was a pretty big number and a Billion was a very big number. But I think the Trillions of this and Trillions of that, that are becoming so commonplace in every discussion on our TV sets, would make it fair to say that the garden is truly infested. As I write this, Bloomberg Television is on, across the room and the politicians are asking Mr. Bernanke and Mr. Geithner why it is a good idea to spend more “Trillions” of your grandkids money to buy what last week they called “Toxic Assets” but this week, in true marketing genius, they have re-named “Legacy Assets ”

Now, somebody must think this is a good idea, because the stock market is up 15 % on the news.

So, is the worst over; are stock market values a bargain; have we escaped a depression? Well my answers to those questions are: No, No, and probably not.

The following article by Robert Prechter should help clarify this position. Mr. Prechter and his Elliott Wave International organization are a valuable source of thoughtful and detailed information and I recommend that you consider joining Club EWI (sign up is free) in order to access the many free resources they provide.

Click Here to visit the ElliottWave.com  site.  Select “Free Stuff” from the menu and sign up for Club EWI

Are We Near a Low in the Stock Decline?
Two Unique Charts Reveal the Answer
March 19, 2009

Robert Prechter, New York Times best-selling author and renowned market analyst, was recently asked to present his thoughts on the real estate market and the financial crisis to the Georgia Legislature. The following article has been adapted from the transcript. Elliott Wave International has made the full presentation available free, including the full transcript and 30-minute online video.

By Robert Prechter, CMT

I’d like to try to answer a question: “Are we near a low in the stock decline?” Because in these times when stocks and real estate are declining together, they tend to bottom roughly together as well. So I want to take a minute and look at a valuation chart for the stock market.

What we have here on the “X” axis is the bond yield/stock yield ratio for the S&P 400 companies. Sounds fancy, but all it means is that the further you go out to the right, the less companies are paying in dividends compared to what they are paying on their IOUs—on their bonds. On the “Y” axis we have stock prices relative to book value. Book value is roughly equivalent to liquidation value, in other words, if you went and sold all the assets on the open market. When stocks get expensive, prices tend to rise relative to book value, and dividends tend to fall relative to the cost of borrowing. Why does that happen? At such times, people don’t really care about dividends because they think they are going to get rich on capital gains. So dividend payout falls, and stocks get more expensive.

The small square boxes indicate year-end figures. The large box is a general area that has contained values for the stock market for most of the years of the 20th century. We had a few outliers: 1928 and August 1987, which preceded crashes in the stock market. And of course stocks were really cheap in the early ’30s and again in 1941. If you are really astute, you have noticed something about this chart, which is that I’ve left off some of the data. It ends in 1990. What happened in the past two decades? Now I’m going to show you same chart but with the data from the last two decades on it. The March 2000 reading we call Pluto. Real estate wasn’t so bad; I think it only got to about Neptune. But the stock market reached Pluto in March of 2000 in terms of the bond yield/stock yield ratio and the price multiple of the underlying values of companies. That’s going to take quite awhile to retrace.

I’ve also plotted the reading for November 2008. The market has made quite a trek back toward normal valuations, but if you look at these multiples in terms of book value, we are at 4 times. It has to go down to 2 times to get back into the box, and we are getting there on the bond yield/stock yield ratio which means that the dividend payout is rising somewhat to catch up with borrowing costs. And because the S&P is down 45%, of course, the dividend payout as a percentage has gone up. But there is a problem there. If you’re reading the newspapers, you know that companies have been cutting dividends. In fact, they’ve been cutting them at the fastest rate in half a century. So it is going to be difficult for values to get back to a normal valuation range. So the stock market has quite a bit lower to go in order to catch up with normal values, and this suggests that real estate may have the same sort of trend going on.

My grandkids like to play a game on my old computer. It requires them to bop gophers on the head when they pop out of their holes.  If they succeed, they earn points but if they miss or, if the pop-up that they hit is dynamite instead of a gopher, they have to start over.

It seems to me that the US Federal Reserve is playing a real-life similar game in trying to manage the economy through its manipulation of interest rates.  There are so many gophers popping up they don’t know which one to take aim at next. Let’s put names on the gophers: sub-prime mortgage, hedge funds, oil prices, financial derivatives, weak US dollar, out-sourcing of jobs,  bond market vigilantes, stock market risk.  Some of these gophers are suppressed by the September interest rate cut but others can become dynamite.

With so many gophers just waiting to pop up in front of Mr Bernanke, it should be interesting to see which one he swings at next !

 This past weekend, a long time friend and colleague reminded me that, exactly 20 years ago, he and I  were participating in a brokerage industry seminar at a top quality resort near the Rocky Mountains.  Times were good, the markets were bullish, the food and drinks were plentiful and the Greed was rampant.  It made me nervous !   Too much euphoria, too many over confident newbie brokers.  I remember asking one of the high-profile speakers about the risk of default for AAA rated US debt.   He laughed at that idea and yes, that was exactly one month before “Black Monday,”  October 19, 1987.  The markets plunged 23 % in one day!  Since then  we have had the Lincoln Savings collapse in 1989, the Long Term Capital Management scare in 1998,  the dot-com bubble burst in 2001, and now the sub-prime mortgage & housing debacle which is ongoing.   Check out the story  of  Northern Rock PLC  on :

http://www.frontlinethoughts.com