Many of our viewers are very concerned about this rally and are wondering if we are posting fewer comments because we are not sure if this rally is the “real thing” or not. This is absolutely not the case. We are just as convinced about this rally as we were with every other rally since the bear market started. In all candor, we felt that we were saying the same thing over and over and now feel that our viewers would get just as much out of two comments a week as you did with five.
We have said for some time that after experiencing the largest financial mania in all of history, we would have to witness significant capitulation by the public and foreign investors before the next major bull market could commence. This type of panic selling, we believe, will drive the stock market to much lower valuations than we have presently. We are talking about valuations that will be closer to the levels at the major lows of the past century such as 1932, 1949, 1974, and 1982. These major lows were at valuation levels of below 10 times earnings and all (but one)were at dividend yields of over 6%. The only one that wasn’t achieved at 6% was 1974 and that was close to 6%.
Many of the bulls try to point out that the reason today’s multiples and dividend yields are reasonable is because inflation and interest rates are so low. We don’t accept that premise because using current, but fleeting interest and inflation rates to determine reasonable P/E ratios are extremely hazardous as was clearly illustrated in 1982. At that time, interest rates and inflation rates were well into double digits, leading most pundits into the erroneous belief that the market was not undervalued at seven times earnings. This turned out to be one of the most undervalued periods of the century.
Another problem we have with the earnings that are being reported presently is the quality of those earnings. For example, today Applied Materials just reported “pro forma” earnings of 3 cents a share versus the estimate of 1 cent. We haven’t had time to look closely into the earnings, but we noticed that AMAT declined after the release. Maybe investors and traders are catching on to the fact that pro forma is even worse than “operating earnings” and both are inferior to “reported earnings”.
Besides the economy, which we believe is much weaker than almost all economists; the other metrics that have to fall into place to achieve another major bottom have to do with sentiment. In our opinion we will not be able to bottom when the VIX is near the areas that are typically seen at stock market tops not bottoms (low 20's). The bulls, as reported in Investors Intelligence, are 55.8% (close to the 5 year high of 61.8%) and bears are at 24.4% which is close to the 5 year low of 22.7%.
Taken all together, excess public and foreign participation has to be liquidated, the valuations must become much more attractive, and the sentiment numbers must turnaround before a major stock market bottom is possible.
"The point at which a competitor is pursuing the best possible strategy, given the strategies of the other participants" - John F. Nash
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