2010 Outlook
By Jason Tillberg January 3, 2010
It is of my opinion that we are in a general economic bust that will last 10-15 years. More or less like the period of 1930 to 1942 and from 1969 to 1982, both lasting 13 years and 14 years, respectively. Our "bust" started around 2008 and thus should last until around 2018 to 2023. Many sectors and investments will bottom out completely at some point within this bust period. Stocks bottomed out in late 1932 while the economy continued to struggle up until the war. Much of the 1970's were met with high rates of unemployment and high rates of inflation.
These are all normal economic cycles, and rather than worrying, it's best to be prepared and opportunistic about them.
The great buying opportunities for stocks and real estate are yet to come. The recent stock market rally has reached far beyond what I would have thought possible given the level of crisis we just went through. How valuations increased to bubble-like levels is a question that does not seem explainable.
The level of debt we need to get through, either by default or pay off, is enormous. A real recovery can begin only when much of this debt is eliminated or restructured. What we are doing now is simply extending the payment dates and pretending there will be a recovery in asset prices.
Let's look at a comparisn of 4 of the greatest bear markets and where we stand today.
This chart gives some justice to just how far we've come relative to other market crashes and what occurred in the years ahead.
There were some points in the crash of 2008 and early 2009 where we were falling faster than we did in the 1929/1930 crash!!
The divergence of this bear market rally lasting as long as it has, in my opinion, is due to all the government intervention into the market systems. Many are surmising that the Treasury and the Fed are directly propping up the market via futures contracts. Although this is difficult to prove, to many including myself, it's naive to think they are not.
If we were to more accurately suggest that the bear market in stocks started at the peak in 2000, then we can look at this chart to see where we stand today relative to two other long lasting bear markets.
From looking at this chart, we can get the sense that even over the next 10 years, stock returns may not prove to be so fruitful.
Now simply, we have to ask ourseves, are stocks overvalued based on historical valuations?
One of the most popular measures of stock valuation is the price to earnings ratio. The S & P 500 is an index of 500 of the largest publically traded companies in America.
The S&P 500 index is currently at 1115.10.
The total "reported earnings" for the S & P 500 for 2009 is estimated to be 49.26.
That would make the current P/E ratio of the S & P 500 22.63.
Historically, the average P/E ratio for any given year since 1871 has been 15. It was as high as 127 this past March when the earnings from the previous 12 months were only 6.86. That was due largely to a loss of $23.25 in Q4 2008.
In 1934, an investor named Benjamin Graham, who was also Warren Buffett’s professor at Columbia University, created a valuation methodology that averages the previous 10 years earnings and takes the monthly close of the index for the previous 12 months to get an average price. This is known as P/E10. The average price over the last 12 months is called the P. Divide the P by the average earnings over the last 10 years to get the E.
Judgeing by the chart below, we can see that we have spent much of the late 90's and the last decade in overvalued territory. But we have been regressing to th mean since 2000. This regression to the mean is still ongoing. There is a high chance we will again see that P/E10 down in the single digits again. Something not unreasonable. The most likely way for that to happen is for the P or the price of the S & P 500 to go down.
As your money manager, I want you to be cash rich when that happens so to be in a great position to make the real buy of a generation then. The lows in March should prove to have not been the lows in the stock markets. This recent stock market rally is simply a bear market rally. How long it lasts is anyones guess. Last week could have been the top. This month could be the top or I could be simply way off base and the top will be in 2012 when I would have thought would have been the bottom.
Clearly, stocks are overvalued as we are at the top end of this ratio with the P/E10 at 20.5. Historically, the P/E10 does not stay above 20 very long.
Another easy metric to help us see the valuation of stocks today is the dividend yield. The dividend is the amount of money the company sends back to shareholders from their profits. Depending on the price of the asset will determine the yield of the dividend.
Below is another great chart from a retired Ph.D. named Doug Short. www.dshort.com is his website. This chart shows dividend yields on the S & P 500 since 1871.
The most telling observation about this chart shows that from 1871 to 1982, the average dividend yield was nearly 5%. But from 1983 to present, the average yield has been just 2.54% and as low as 1.1% in 2000.
The maker of this chart attributes this to the baby boom generation more concerned about price appreciation vs. income. Also, this investor group did not live through the great depression or the bear market of 1968 - the early 80's.
In my opinion, I think this is going to revert back to a higher dividend yield meaning stocks will fail to be a strong performing asset class.
The last item I want to leave you with is the current level of investor sentiment. Investors are fearless and bullish. There are currently very few who think stocks will go down. This makes me bearish. Be fearful when others are greedy.
Summary
The information I provided is only just the tip of the iceburg of the issues surrounding the economy and the investment environment. The sum of all the parts that I know of with respect to the US Economy, the present situation is dire and far more likely in my opinion to only get worse as States tackle bankruptcy ahead and the ability for the Federal Government to continue to borrow becomes more and more difficult.
With inflation at or near 3% year over year, interest rates will have to start rising. It's baffleing banks can get away paying next to 0% interest in savings accounts with inflation at 3%. It's also baffleing that the Treasury can sell 2 year treasury notes that yield only .80% and 10 year treasury notes that yield only 3.8%.
With respect to stock market valuations, the S & P 500 can fall 50% today and the dividend yield will only be around 4%, still below the average dividend yield of nearly 5% from 1871-1982. Such a fall is far more likely than not to come in my opinion.
Althought this investment environment is extremely difficult to predict, we will continue to hold positions that are in need of price corrections. Patience is required however for this strategy to work out. .
Disclosure: This newsletter is not a means to solicit any of the securities mentioned nor does it recommend it for any person before they speak with a licensed professional investment advisor for their own suitability. Investing in Equities bears risk of capital loss. This newsletter is strictly the opinion of Jason Tillberg, President and founder of Tillberg Capital Management, Inc. and shall not be held responsible for investment loss from this newsletter.
