Comstock Partners, Inc.January 16, 2014
The Market Is In Dangerously High Territory
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.