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.

 

 
 

 
 

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:

  • The Biggest Stock Market Crashes Tend to Happen in October
      October is the Most Dangerous Month The prospect of steep market declines worries investors – and the month of October has a particularly bad reputation in this respect.   Bad juju month: Statistically, October is actually not the worst month on average – but it is home to several of history's most memorable crashes, including the largest ever one-day decline on Wall Street. A few things worth noting about 1987: 1. the crash did not presage a recession. 2. its...
  • Fed Quack Treatments are Causing the Stagnation
      Bleeding the Patient to Health There’s something alluring about cure-alls and quick fixes. Who doesn’t want a magic panacea to make every illness or discomfort disappear? Such a yearning once compelled the best and the brightest minds to believe the impossible for over two thousand years.   Instantaneous relief! No matter what your affliction is, snake oil cures them all. [PT]   For example, from antiquity until the late-19th century, bloodletting was used to...
  • Canada: Risks of a Parliamentary Democracy
      A Vulnerable System Parliamentary democracy is vulnerable to the extremely dangerous possibility that someone with very little voter support can rise to the top layer of government. All one apparently has to do is to be enough of a populist to get elected by ghetto dwellers.   Economist and philosopher Hans-Hermann Hoppe dissects democracy in his book Democracy, the God that Failed, which shines a light on the system's grave deficiencies with respect to guarding liberty. As...
  • Federal Reserve President Kashkari’s Masterful Distractions
      The True Believer How is it that seemingly intelligent people, of apparent sound mind and rational thought, can stray so far off the beam?  How come there are certain professions that reward their practitioners for their failures? The central banking and monetary policy vocation rings the bell on both accounts.  Today we offer a brief case study in this regard.   Minneapolis Fed president Neel Kashkari attacking a block of wood with great zeal. [PT] Photo credit: Linda Davidson...
  • Thoughtful Disagreement with Ted Butler
      Too Big to Fail?   Dear Mr. Butler, in your article of 2 October, entitled Thoughtful Disagreement, you say:   “Someone will come up with the thoughtful disagreement that makes the body of my premise invalid or the price of silver will validate the premise by exploding.”   Ted Butler – we first became aware of Mr. Butler in 1998, and as far as we know, he has been making the bullish case for silver ever since. Back in the late 90s this was actually a...
  • Donald Trump: Warmonger-in-Chief
      Cryptic Pronouncements If a world conflagration, God forbid, should break out during the Trump Administration, its genesis will not be too hard to discover: the thin-skinned, immature, shallow, doofus who currently resides in the Oval Office!   The commander-in-chief - a potential source of radiation?   This past week, the Donald has continued his bellicose talk with both veiled and explicit threats against purported American adversaries throughout the world.  In...
  • Precious Metals Supply and Demand Report
      Fat-Boy Waves The prices of the metals dropped $17 and $0.35, and the gold-silver ratio rose to 77.  A look at the chart of either metal shows that a downtrend in prices (i.e. uptrend in the dollar) that began in mid-April reversed in mid-July. Then the prices began rising (i.e. dollar began falling). But that move ended September 8.   Stars of the most popular global market sitcoms, widely suspected of being “gold wave-makers”. From left to right: Auntie Janet...
  • The Donald Can’t Stop It
      Divine Powers The Dow’s march onward and upward toward 30,000 continues without a pause.  New all-time highs are notched practically every day.  Despite Thursday’s 31-point pullback, the Dow is up over 15.5 percent year-to-date.  What a remarkable time to be alive.   The DJIA keeps surging... but it is running on fumes (US money supply growth is disappearing rapidly). The president loves this and has decided to “own” the market by gushing about its record run. During...
  • 1987, 1997, 2007... Just How Crash-Prone are Years Ending in 7?
      Bad Reputation Years ending in 7, such as the current year 2017, have a bad reputation among stock market participants. Large price declines tend to occur quite frequently in these years.   Sliding down the steep slope of the cursed year. [PT]   Just think of 1987, the year in which the largest one-day decline in the US stock market in history took place:  the Dow Jones Industrial Average plunged by 22.61 percent in a single trading day. Or recall the year 2007,...
  • Stocks Up and Yields Down – Precious Metals Supply & Demand
      Where the Good Things Go Many gold bugs make an implicit assumption. Gold is good, therefore it will go up. This is tempting but wrong (ignoring that gold does not go anywhere, it’s the dollar that goes down). One error is in thinking that now you have discovered a truth, everyone else will see it quickly. And there is a subtler error. The error is to think good things must go up. Sometimes they do, but why?   Since putting in a secular low at the turn of the millennium,...
  • The 2017 Incrementum Gold Chart Book
      A Big Reference Chart Collection Our friends at Incrementum have created a special treat for gold aficionados, based on the 2017 “In Gold We Trust Report”. Not everybody has the time to read a 160 page report, even if it would be quite worthwhile to do so. As we always mention when it is published, it is a highly useful reference work, even if one doesn't get around to reading all of it (and selective reading is always possible, aided by the table of contents at the...
  • Precious Metals Supply and Demand
      Fundamental Developments The prices of the metals shot up last week, by $28 and $0.57.   Heavy metals became pricier last week, but we should point out that the stocks of gold and silver miners barely responded to this rally in the metals, which very often (not always, but a very large percentage of the time) is a sign that the rally is unlikely to continue or hold in the short term. [PT]   Last week, we said:   “One way to think of these moves is...

Support Acting Man

Top10BestPro
j9TJzzN

Austrian Theory and Investment

Archive

350x200

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

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]

 

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com