You’re Not Over the Hill If You Don’t Remember Any Hill …

Yesterday, we turned 66 years old. When did we get so old? We can’t remember. But 66 is still young. Everybody says so. Especially mother, who is 93, and our uncle, who is 96.

For our birthday, we went with Elizabeth to Le Dôme du Marais – a nice restaurant in the Marais district of Paris. It’s housed in a handsome round building that was once a pawnshop.

The pawnshop had been set up, explained the menu, by Louis IX to combat usury. In the days before credit cards, people could come to the pawnshop, rather than going to loan sharks, for their financing needs. Le Marais is a charming part of the city. Narrow streets. Ancient buildings. Chic shops. It is much more fashionable and cosmopolitan than our neighborhood.

At one table was a group of young professionals (perhaps in finance) – some from England, some Americans, an Asian… and others. It looked very much like a group you’d see in London or New York. At another table was a couple we took to be Scandinavian… or Russian. An American couple sat at yet another table but left early.

“That didn’t seem like Paris,” said Elizabeth. “It could have been anywhere.” Now, the small talk out of the way, let us return to our main subject: how to invest intelligently in an uncertain world.

A Simple System to Beat the Market

The Dow has traded at more than 20 times earnings six times in the last 114 years: at the start of the 20th century, in the late 1920s, in the mid-1930s (because earnings were so low), in the 1960s, in the 1990s, and twice in the new millennium.

Each time, save the last, a bear market followed that brought stock prices back to more reasonable valuations. The Dow has traded below 10 times earnings only three times over the same period: between about 1915 and 1925, after the crash of 1929 off and on until 1945, and between about 1977 and 1984. (The dates are approximate, because P/E ratios are slippery.)

Each time was a buying opportunity. Stocks rose substantially subsequently. Our “Simple Trading System” (STS) couldn’t be simpler.

 

P/E > 20 = Sell

P/E < 10 = Buy

 

When stocks are above 20 times earnings, you are out. When they fall below 10 times earnings, you buy again. Otherwise, you do nothing.

Had you come to adulthood in 1900… and somehow lived to today… following STS, you would have saved yourself the worst drawdowns. And you would still have taken advantage of the big bull markets of the 1920s, the 1960s, the 1980s, and the 1990s (and even the bull markets of the 2000s, depending on how you calculated your P/E ratio).

Note: If you had been using Robert Shiller’s 10-year average inflation-adjusted measure, you would have been out of stocks since the late 1990s. His “Shiller P/E” never fell below the 10-times-earnings entry mark.

Easy peasy, right?

Your rate of return would have been far in excess of buy and hold. But the real beauty of the STS is that you don’t have to be too exact about it. The system is meant to help you get the big moves right; the details almost don’t matter.

 

SPX valuationSPX with GAAP earnings and trailing P/E – obviously, P/E ratios are not the only determinant of future returns, but avoiding buying an expensive market has definitely helped with avoiding all the worst crashes and bear markets – click to enlarge.

 

Better Than the Shiller P/E

Our old friend Stephen Jones has been studying the essential question for decades. He has come up with an even better way to determine the real value of the stock market and its likely direction – better, I believe, even than Robert Shiller’s 10-year P/E and Tobin’s Q (which looks at the market value of listed companies relative to the replacement value of those companies’ assets).

Jones says that earnings – the denominator in the P/E ratio – are misleading. They can be goosed up by unsustainable trends. And that is exactly what has happened now: Earnings are greatly flattered by the Fed’s easy credit.

An alternative is to look at total output – GDP – and then adjust it according to the macro trends that are sure to affect it. The two main trends right now are debt and demographics. Both are major influences on growth. As debt increases, and a population ages, GDP declines.

Jones put those figures into his model … and found the resulting indicator was more accurate than any other market-forecasting tool.

 

Q-RatioTobin’s Q ratio, via Doug Short. Today’s value was only eclipsed by the late 90’s tech mania, which is not the proper yardstick for determining overvaluation. It is noteworthy though that we’ve left the 1929 peak in the dust already – click to enlarge.

 

Another Lost Decade?

What does Jones’s model tell us now?

First, US stock prices are well over 20 times earnings when earnings have been properly normalized…or “smoothed” … as Shiller would do it (P/E > 20). Second, the model forecasts annual returns of MINUS 10.5% for the next 10 years.

Simple and obvious advice: It’s a good time to stay out of the stock market for long-term investors. But wait … If this is so simple, surely the smart money must have seen it?

Surely, it noticed that stocks were sometimes cheap and sometimes dear?
Surely it realized that investors were moved by greed and fear … and that they frequently mispriced stocks?

And what about all those guys with PhDs on Wall Street? Don’t they know about the anomalies Porter mentioned yesterday? Don’t they see all the $100 bills that are lying on the ground, just waiting to be picked up? Don’t they know they can time the stock market – at the extremes – as our STS does? Of course they do!

Next: What’s wrong with the “smart money?” How come it leaves so much money available for investors like us? Is it not so smart after all?

 

Poster - Smart Money (1931)_05“Smart Money” – a movie about a man who knows too much about cards and too little about blondes …

 

The above article is from Diary of a Rogue Economist originally written for Bonner & Partners. Bill Bonner founded Agora, Inc in 1978. It has since grown into one of the largest independent newsletter publishing companies in the world. He has also written three New York Times bestselling books, Financial Reckoning Day, Empire of Debt and Mobs, Messiahs and Markets.

 

 
 

Emigrate While You Can... Learn More

 
 

 
 

Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke

   
 

One Response to “The Simple Math Behind the NEXT Lost Decade in US Stocks”

  • wrldtrst:

    I have really enjoyed reading your commentaries the past few years, strong free market libertarian bend, and a nice style of writing that is engaging, humorous, and cynically intelligent. Wondering if you are going somewhere with the ‘Porter’ comments. As someone from DC/MD I remembered the name, and looked him up.
    Scary ‘dude’ to be quoting. Staying to my own personal strength. His comments about put selling are so incorrect, disingenuous, and intellectually dishonest, wither he knows nothing, or more likely knows his audience knows even less.

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • What Do “Think Tanks” Think About?
      “Russiagate” WEST RIVER, MARYLAND – We’re back at our post – watching... reading... trying to connect the dots. And we begin by asking: What do “think tanks” think about? The answer in a minute. First, there is a dust-up in the Washington, D.C., area. “Russiagate,” it is called. As near as we can make out, some people think the Trump team had or has illegal or inappropriate contacts with the Russian government.   It's all very obvious, if one looks...
  • Parabolic Coin
      The Crypto-Bubble - A Speculator's Dream in Cyberspace When writing an article about the recent move in bitcoin, one should probably not begin by preparing the chart images. Chances are one will have to do it all over again. It is a bit like ordering a cup of coffee in Weimar Germany in early November 1923. One had to pay for it right away, as a cup costing one wheelbarrow of Reichsmark may well end up costing two wheelbarrows of Reichsmark half an hour later. These days the question is...
  • Quantitative Easing Explained
      [Ed. note: This article was originally posted in November of 2010 - we have decided to republish it with updated charts, as it has proved to be very useful as a reference - the mechanics of QE are less well understood than they should be, and this article explains them in detail.]   Printing Money We have noticed that lately, numerous attempts have been made to explain the mechanics of quantitative easing.  They range from the truly funny as in this by now 'viral' You Tube...
  • The Three Headed Debt Monster That’s Going to Ravage the Economy
      Mass Infusions of New Credit   “The bank is something more than men, I tell you.  It’s the monster.  Men made it, but they can’t control it.” – John Steinbeck, The Grapes of Wrath   Something strange and somewhat senseless happened this week. On Tuesday, the price of gold jumped over $13 per ounce.  This, in itself, is nothing too remarkable.  However, at precisely the same time gold was jumping, the yield on the 10-Year Treasury note was slip sliding down...
  • Jayant Bhandari on Gold, Submerging Markets and Arbitrage
      Maurice Jackson Interviews Jayant Bhandari We are happy to present another interview conducted by Maurice Jackson of Proven and Probable with our friend and frequent contributor Jayant Bhandari, a specialist on gold mining investment, the world's most outspoken emerging market contrarian, host of the highly regarded annual Capitalism and Morality conference in London and consultant to institutional investors.   As soon as Jayant touches down in London, he is accosted by...
  • Monetary Madness and Rabbit Consumption
      Down the Rabbit Hole “The hurrier I go, the behinder I get,” is oft attributed to the White Rabbit from Lewis Carroll’s, Alice in Wonderland.  Where this axiom appears within the text of the story is a mystery.  But we suspect the White Rabbit must utter it about the time Alice follows him down the rabbit hole.   Pick a rabbit to follow...   No doubt, today’s wage earner knows what it means to work harder, faster, and better, while slip sliding behind. ...
  • Central Banks – Tiptoeing Toward the Exit
      Frisky Fed Hike-o-Matic We haven't commented on central bank policy for a while, mainly because it threatened to become repetitive; there just didn't seem anything new to say. Things have recently changed a bit though. A little over a week ago we received an email from Brian Dowd of Focus Economics, who asked if we would care to comment on the efforts by the Fed and the ECB to exit unconventional monetary policy and whether they could do so without triggering upheaval in the markets and...
  • The Anatomy of Brown’s Gold Bottom – Precious Metals Supply and Demand
      The Socialist Politician-Bureaucrat with the Worst Timing Ever As most in the gold community know, the UK Chancellor of the Exchequer Gordon Brown announced on 7 May, 1999 that HM Treasury planned to sell gold. The dollar began to rise, from about 110mg gold to 120mg on 6 July, the day of the first sale. This translates into dollarish as: gold went down, from $282 to $258. It makes sense, as the UK was selling a lot of gold... or does it?   Former UK chancellor of the...
  • The Valium Era
      Don’t Be Fooled by These Calm Markets What is happening in the world of money? Well - the most striking thing is: nothing. It doesn’t seem to matter what happens. Dysfunction in Washington. Meltdown of the techs. No matter how rough the seas get, the markets glide along... scarcely noticing the storm-tossed waves below.   Thankfully the world's central planners are so well-versed in egging on the creation of an ever greater mountain of debt and seemingly limitless asset...
  • Is Trump a Modern Caesar?
      Putting on the Purple   Mayor: Drebin, I don’t want any more trouble like you had last year on the South Side. Understand? That’s my policy. Drebin: Yes. Well, when I see five weirdos dressed in togas stabbing a guy in the middle of the park in full view of 100 people, I shoot the bastards. That’s my policy. Mayor: That was a Shakespeare in the Park production of Julius Caesar, you moron! You killed five actors! Good ones. – The Naked Gun   Laura Loomer,...
  • The Fed Rate Hike and Gold – Precious Metals Supply and Demand
      Shrinking the Balance Sheet? The big news last week came from the Fed, which announced two things. One, it hiked the Fed Funds rate another 25 basis points. The target is now 1.00 to 1.25%, and there will be further increases this year. Two, the Fed plans to reduce its balance sheet, its portfolio of bonds.   Assets held by Federal Reserve banks and commercial bank reserves maintained with the Fed – note that while asset purchases and bank reserve creation are connected,...
  • How to Discover Unknown Market Anomalies
      Seasonax Event Studies As our readers are aware by now, investment and trading decisions can be optimized with the help of statistics. After all, market anomalies that have occurred regularly in the past often tend to occur in the future as well. One of the most interesting and effective opportunities to increase profits while minimizing risks at the same time is offered by the event studies section of the Seasonax app.   A recent event that had quite an impact on certain...

Support Acting Man

Austrian Theory and Investment

Own physical gold and silver outside a bank

Archive

j9TJzzN

350x200

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com