In January 1973 Barron’s Magazine summarized its annual
roundtable discussion with the front-page headline entitled “Not a Bear Among Them”. The
market proceeded to drop about 50% over the next 21 months. In our view the current market situation
bears a great deal of similarity to that period 41 years ago. Investors are almost unanimously bullish and
the market is significantly overvalued.
In fact, one columnist wrote: “It is official; almost all the bears are
dead.” History shows, however, that
whenever investors are overwhelmingly bullish the market enters a major decline
that does not end until most investors become exceedingly pessimistic and the
market drops to undervalued levels. In
our view, the current period will be no exception.
The high degree of bullishness is evident in a number of measurable
indicators as well as in anecdotal material appearing in the media. As illustrated in Ned Davis Research, stock
market capitalization as a percentage of Domestic Gross Income is now 126%,
compared to 87% in 1929, 164% in 2000, and 125% in 2007. On the other hand, it was only 31% at the
1982 low and 58% in March 2009 at the depth of the credit crisis.
The American Association of Individual Investors survey
shows investors allocating 68% to stocks, compared to 77% in 2000 and 70% in
2007, while their cash allocation of 16% is lower than in 2007. The Investors Intelligence Survey of market
newsletters indicates 56% bulls this week and 60% last week, near the highs of
2000 and 2007. Only 15% were bearish, the lowest amount in 27 years, going back to 1987, and we all know what
followed. Margin debt is at record highs
in dollar terms, and is 2.04% of market value, compared to a 69-yrear average
of 1.18%. The current percentage was
exceeded only in 2007.
This overly exuberant sentiment is also happening at a
time when the market is highly overvalued.
The S&P 500 is selling at 21.6 times cyclically-smoothed reported
(GAAP) earnings, compared to a historical average of about 15 and cyclical lows
of below 10. The price-to-sales ratio is
1.65 times, higher than in 2007, and well above the peaks of about 1.30 in the
period from 1955 through the late 1990s.
Momentum, too, is slowing down as fewer and fewer stocks
are participating in the rise. At
yesterday’s (Wednesday) market high, 69%
of S&P 500 stocks were above their 50-day average and 79% above their 200-day
average, the lowest rate at any 52-week high since 2007. In addition, over 600 stocks were making new
daily highs in October, but only about 200 currently.
In sum, the market appears to be losing momentum at a time
when it is significantly overvalued and when investors are highly bullish. If history is any guide----and we believe
that it is----stocks are in dangerously high territory, and the potential
upside rewards compare unfavorably to the substantial downside risks.