As the stock market continues its upward climb toward the 9000 level, fundamental analysts have got to be concerned about the continued ascent. There are several straws in the wind that make this observer wonder if we have not seen a market that may be ready for a significant correction.
1. Price/earning ratios on the Dow-Jones Industrial Average have exceeded all-time highs.
2. Historically, the market is seeing price/book value ratios that are way above anything in history. The younger analysts are talking about price/sales ratios. Thirty years ago, no one had even heard about price/sales ratios.
3. Prices of just 10 NASDAQ Internet stocks (not including Microsoft) exceed the combined value of all the 30 Dow-Jones Industrial Average Stocks. Talk about selling the expectation of profits as opposed to the reality of profits. And last year, the combined profit of those 10 NASDAQ stocks was a whopping $1 billion + loss.
4. Money flowing into mutual funds from 401K and other sources continues to bid up prices. The so-called soccer mom’s have never seen a major decrease in their portfolios.
5. Overseas flows into the U.S. continue at an accelerating pace as money tries to escape the volatile currency fluctuations of the Pacific Rim countries, Latin America and South America. The IMF is staggering under the bailouts of nations throughout the world. Only the generosity of the American taxpayer has prevented the world financial condition from reaching panic levels. Many countries have seen riots in the streets caused by the currency devaluations and bank failures.
6. Like 1928/1929, an increasing number of U.S. citizens are investing in the stock market. Despite increased margin requirements, many stocks are volatile and day-trading momentum can often swing a stock price by 10 to 25% a day.
7. The federal government has decided to take up the fight against Microsoft, arguably, the most successful company in the free world during the past 20 years. Microsoft’s competitors were unable to defeat the company in the competitive world so have decided to try to enlist Lawyers and bureaucrats to destroy it.
8. Political gridlock continues with the politicians fixated on the Lewinsky affair. Almost no progress has been made on appropriations for fiscal 99, foreign policy is almost non-existent, and the mid-term elections are only 4 months away.
9. The polls indicate that the public is tired of the Lewinsky affair and Clinton continues to receive high marks for his handling of the economy. It is a mark of the public’s lack of understanding of economics when they think that the President has anything to do with the economy. Allen Greenspan at the Federal Reserve, Congress, and the independent decisions of business people throughout America impact the economy more.
10. The U.S. balance of payments deficit continues to increase, the Japanese economy and its banking industry are in terrible shape, and foreign currency markets are extremely volatile. The economies of the old Soviet Union are in extreme difficulty, and the Mid-East continues to simmer.
11. And most ominously of all, commodity prices have been in a free-fall for almost a year. Prices of grains, livestock, oil, etc., are way off their highs of last fall. The most important sector of our world-wide economy, agribusiness, is certain to see major problems this year. Iowa State University has projected that 1998 farm revenues will be off by 60% from last year. If this happens, many ranchers and farmers will be forced into bankruptcy. And those bankruptcies will ripple throughout the economy.
Taking profits is never a bad idea but you have to pay taxes on them.
Greenspan believes that inflation is under control and some financial guru's are predicting a drop in the fed funds and/or discount rate in the near future. Most of these guru's don't understand that today's dollar is worth less than a nickel in terms of 1900's purchasing power. Some control!
Take off from your day job to monitor the market. Use momentum analysis and O'Neils 5% drop rule to play the movers. The market is likely to be extremely volatile as the bulls and bears wage war during the coming months. The increased number of day-traders will continue to make the market see-saw.
Evaluate your portfolio for market leaders of superior management quality, market position and financial strength. Reduce positions in companies with significant debt leverage. In the growth portion of your portfolio, be aware of changing momentum numbers and be ruthless in applying your standards of quality. Decrease your stock portfolio positions to no more than 20 equity issues. Increase your fixed income portfolio by at least 10% by investing in AAA issues and/or U.S. Treasury 30 year bonds. Get out of any mutual funds that have not appreciated at least 25% in the last six months. And consider the long-term appreciation of the rest. Most investors by applying the CANSLIM screens and the 180 EPS-RSI standard can beat the average mutual fund return in any year.
The real question facing the long-term investor is whether to increase the cash/bond portion of the portfolio by more than 10% at this time. If the market drops by 20% to near the 7,000 level, selling stocks at this time will be very profitable. If, however, the market only drops 5%, the cost in taxes may make the decision "iffy" depending upon the individual's overall tax situation.
The current state of the market makes this observer very nervous. At these levels, the stock market seems over-priced based upon historical values. Whether we are near or at the peak of the current market is not the point. The point is that every expansion and market cycle eventually reaches that point of the pendulum where it begins to go the other way.
The turmoil in overseas markets will affect our own service oriented economy. As a result, the economy will slow down, and eventually prices will fall. Mergers within the financial industry continue at an increasing pace - - but service to the financial industries customers continues to fall and be more costly.
It is not a good time to go on vacation . . . it is a time when all investors must seriously evaluate the contents of their portfolios and decide for themselves what is a proper balance. Markets don't always go up . . . not in 1929 and I doubt if they will in 1998. So be careful . . . the day of reckoning may be close at hand!
But then . . . 'Tis Only My Opinion!
Fred Richards
July 1998
This issue of 'Tis Only My Opinion was copyrighted by Adrich Corporation in July 1998.
All rights reserved. Quotation with attribution is encouraged.
Tis Only My Opinion is intended to provoke thinking, then dialogue among our readers.
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Last updated - July 3, 2008