Joining the fray has never been one of my strong suits. In fact, Fundamentals Guy was a lousy player of team sports, opting instead for skiing, tennis, and lowbrow forms of sports car racing. Not only that, but he never joined, nor did he want to join any fraternity in college. "Strength in numbers" always rang hollow since F. G. figured it to be a weakness if he could not go it alone. That's not to denigrate team sports or fraternization of any sort. But rather to elevate and place greater value on individualistic efforts.
However, today, F. G. breaks into the crowd to become just another guy offering his thoughts on what lies ahead for the markets. Sounds boring, and maybe it is. But I'll try to keep this as entertaining as possible in a sea of otherwise gray voices, Mark Phillips excellent prognostications from yesterday's Options 101 column excepted. See it here if you missed it:
I had promised last week that we'd get to my thoughts on stocks, bonds, interest rates, the dollar, gold and real estate, the last one being my profession for 15 years in a former business life before markets became my new profession. That will be fun to talk about. But for now, everyone's favorite subject is the future of the stock market.
With that in mind let me offer two caveats, one of which is self- serving if I turn out to be horribly wrong, and the second, which is axiomatic, yet goes ignored by 99 out of 100 analysts.
First caveat. I am no guru. I'm just another carbon-based life form reacting to neuro-electric input. Guru's are eventually wrong and I may very well be wrong too when all is said and done.
The problem with gurus is that they end up believing their own hype and fall into defending their position when wrong rather than considering the evidence. Opinionated as I am, I can only react and write about that which the market is telling me, not that which I want to build a position around. Thus, I reserve the right to be 100% wrong and will humbly and deservedly take the slings and arrows if I am. However, my individualistic inclination is to listen to the markets, not what others are saying about the markets, and to adjust my thinking as the markets suggest I should. (Ken Fisher, money manager and Forbes columnist doesn't call the market "The Great Humiliator" for nothing.)
After all, one of the great tenets of trading comes from the legendary Jesse Livermore (Reminiscences of a Speculator) who notes that, "When a man is wrong, the first thing he should do is cease to be wrong". That's another way of saying what America's first billionaire, John D. Rockefeller, said more than 100 years ago, "It is better to consider evidence than defend a position." If we care to delve deeper into history, "The truth shall set you free."
And as long as we're offering up great quotes to live by, allow me introduce the second caveat, and, hopefully, destroy a self- limiting belief by reframing the supposition of what to expect "in 2003".
Warren Buffet notes (and I'm paraphrasing here since I can't remember his exact words, though I'm sure I'd find them on the Berkshire Hathaway web site buried in a shareholder letter), "Financial performance bears no relationship to the amount of time it takes for the Earth to orbit the Sun." The point is, that though commonly accepted as a default time frame in which the judge financial performance, "one year performance" is arbitrary. So to predict a market's position in 2003, or exactly one year, is at best, a crapshoot. In fact, craps give better odds.
OK, so what do I see in the crystal ball? Forget one-year performance. But like Mark Phillips, I too see lower stock prices in coming months, though I don't know exactly when, mostly for fundamental reasons. Rather than bore us all, let me include a snippet of a Richard Russell column sent by a friend over the weekend. It paraphrases quite nicely a reader letter that appeared in Barron's.
"The reader notes that the S&P dividend yield is currently 1.75%. Many analysts think the yield for the S&P could be boosted to 3% or even 4%. Not so. Currently S&P companies pay out 53% of their earnings in dividends. In 1981, at which time the S&P yielded 6%, its companies paid out 45% of their earnings in the form of dividends. But currently, this can't happen. There just aren't enough earnings. If the current S&P corporations boosted their dividends to just 3.5%, their payout rate would be 106%."
"There are only two other ways the S&P companies could increase dividend yields to 3.5%. They would have to double their earnings or decrease their current share prices by 50%, taking the S&P from about 900 to 450. Thus, it's doubtful whether we'll see any real increase in S&P dividends over the foreseeable future. By the way, even if the yield on the S&P did rise to 3.5%, that figure, 3.5%, used to be characteristic of a TOP in the S&P, not a bear market bottom!"
Amen Barron's reader! That, in a nutshell is why I do not think we will make new highs anytime soon. While I'm not suggesting that 450 is where I see the S&P moving, under current global economic circumstances where Japan is devaluing the Yen (currently at 120 to the dollar and shooting for 150 to the dollar), China is flooding the market with inexpensive goods that we Americans are lapping up, the dollar sliding downward against the Euro, and the worldwide overcapacity in manufacturing is driving prices ever lower, corporate profits (born of a no longer spend-happy U.S. consumers) are going to be hard to come by.
With no pricing power now, and the situation getting worse before it gets better, business is going to have to maintain margins by cutting expenses, aka jobs - not a pretty picture. And for that reason, I would look for unemployment to rise in coming months.
As an aside, for those that point to this week's less than expected jobless claims, the Bureau of Labor and Statistics has all but admitted it makes these figures up and offers a best guess based on their previous best guess. What a waste. The truth is not in their best interest and other more reliable sources show far greater cause for concern than the BLS leads on. Yet, Wall Street touts the BLS number as gospel, even though it knows better.
The point is that without income, and with increasing joblessness, personal debt, bankruptcy, and delinquent home loans at all-time highs, there is not a snowball's chance in Hades that "things" will be better by the end of the year, at least not in my opinion. I will be the first to admit the error if I see evidence to the contrary. But I don't see it anywhere on the radar. The former almighty U.S. consumer is in the early stages of pulling in his/her horns, as the first step of many to come following an orgy of debt. In short, we've been borrowing ourselves rich and its time to pay up. Don't look for profits to rise, which is the ONLY reason stocks should increase in value, on that basis.
That leads me to a tangential issue of Bush's proposed new tax plan. Summarized, I like it, especially the part about eliminating double-taxation on dividends. What is unclear to me still is whether dividend distributions will be exempted at the corporate level, in which case the recipient would pay taxes, or, whether the corporation pays taxes on the income and it becomes tax exempt by the recipient. Either way, that is the single fastest way in the world to free up capital for consumption, retiring debt, or investing in new equipment. That would be good for the economy.
For those in the top tax brackets (aka the ones who pay the majority of taxes already - forced benevolence), next to elimination of the death tax, this is the single greatest key that we have seen in decades to unlocking capital spending and aligning the business of the company to produce profits for the shareholder. Can you tell I'm ecstatic over that prospect?
Anyway, back to the future. Another benefit to elimination of the dividend tax is that it would single-handedly wipe out most companies propensity to report pro-forma earnings (earning before all bad stuff) or EBITDA earnings (earning before I trick dumb auditors). Sub-par companies would have the light of truth shown on them. Do they earn real money to return to the shareholders or not? Can they produce a profit? If not, wave bye-bye to the share price. Honestly, it's always amazed me that investors were so willing to bite on a speculative piece of paper with no earnings and sketchy profit potential. Yet, they would never consider owning a neighborhood pizza parlor that all but guaranteed it would never pay a dime if they owned it.
Accordingly, the metaphoric pizza parlor owner will be forced to make a better pizza in hopes of pulling business revenues from his competitors or going out of business. The new mantras is going to be "profit of die". In the long run, it is impossible to hide losses. Those that do hide them or can't profit will go by the wayside. Again, not good for speculators, but very good for those like me who like a fat, juicy dividend. Yes, I still like Phillip Morris (MO) as it pays a very stable 6%+.
Anyway, I could go on about the state of the economy, the world, taxes, etc. for hours. However, the deadline approaches, and I'm getting long-winded on the subject.
In summary, I don't see a bullish picture for stocks this year and expect the primary trend to remain down, though as J.P. Morgan often noted, "Markets fluctuate". To that end, I have a high expectation that stocks will see new lows sometime this year, interspersed with continued analyst cries that, "This is the bottom" on every new rally. Don't bet on it. Only when we hear analysts say (at least those that are still employed) that they won't touch stocks with a 10-foot pole, that the stock market is a horrible investment, and when values become uncommonly good, the bottom will be found. Until then, bet on the bear in the equity markets.
Next time we'll get to bonds, interest rates, and the inflation/deflation arguments. Comments always welcome. Make a great weekend for yourselves!