High level of risk…yet many stocks are still cheap

THE STOCK MARKET IS IN A PERIOD OF EXCESSES SO INVEST IN WHAT IS UNDERVALUED NOT WHAT IS POPULAR.  Before I start, I want to emphasize that we are always invested in the market as we always find stocks that are undervalued……..many!  We may be bearish for many large caps that have performed well. But our view is that now is the time to take profits in some of them. But we always find numerous stocks that are undervalued and offer the potential for exceptional capital gains; Gold stocks are at the top of the list.

PAYING UP! Too many stocks have been bought over the last six months at high price levels…it may again lead to a painful decline-it has in the past. However, as always there are numerous stocks that are still very undervalued.  It can take years of recovery to work off paying too high a price for any asset whether they are stocks, bonds or real estate. JAPAN HAS NEVER RECOVERED FROM PAYING FAR TOO HIGH PRICES FOR STOCKS, REAL ESTATE AND OTHER ASSETS GOING BACK TO 1989.

CYCLES  Cyclical analysis of the stock market which had been superb for years has not worked for us for three years now. We have been expecting a decline of 20% to 25% for the last three years, each decline to be followed with a return up. But it has not happened and we were wrong. What worked in the past with various indicators has worked as the ingredients for at least interim bear markets have not occurred. Low rates and Fed intervention have prevented the normal decline.

We rode the market up with our advice and said in 2000 to get out of many things above all tech related stocks. I was collaborating with Robert Morrow, who is the finest and most accurate technical analyst that I have seen. Bob advises large institutions and has many times been rated as the number one market timer by Timer Digest for the stock market while also being named as the top timer for bonds and gold. Bob’s analysis is based on Fourier mathematics. The Associated Press often had articles about Bob’s accuracy.  On the side, Bob, an engineer, holds 37 patents in electronics. Bob’s technical analysis which has been affected recently by the near zero interest rates, projects a sharp decline of over 25% to occur from the present levels with little upside left.

GDP TO STOCK MARKET   We study the charts of “value” indicators that show undervaluation and overvaluation. As you may know, the “value of US stocks to US Gross Domestic Product” is currently between 125% to 140%. This is a dangerous overvaluation level of the entire stock market which in the past has led to market declines of 30% to 50% twice in the last 100 years. It has never avoided a brutal bear market decline when carrying these value levels.

PRICE TO SALES RATIO   Another value type indicator of “price to sales ratio” for the entire stock market is now in dangerous territory. In the past these levels have led to enormous stock market declines. In fact it is at the highest level ever! The value of the stocks is now at over two times the gross sales of the companies. Oddly similar, this is now at about 30% over the normal level. For example, let’s say that a company “XYZ Company” has one million dollars in sales and carries a market cap of two million dollars.  Suffice it to say that the price to sales ratio is sending a clear warning for the overall stock market.

NO BEAR MARKET, BUT WHEN? But note that with 1-low interest rates such as we have today, 2-money supply not contracting and 3-the economy not in recession… we do not have the necessity of a major decline. It is when such a decline commences from these valuation levels, the declines historically are brutal. So despite that the “price to sales ratio” measurement and the “stock market to Gross Domestic Product” indicate extreme overvaluation, until rates rise or money supply contraction or a recession, a long overdue bear market does not have to occur.
In 2007, I warned on the old Canaminvestor site to be prudent to say the least. In mid-2008, while writing at an office in Montreal, I wrote an article that I titled “A Midsummer Night’s Scream” in which I said to prepare for the “largest decline in asset values that the world had ever seen.”  It did occur and I used cycles added to ludicrously high valuations to project the decline. By studying some important cycles and valuation models, my indicators suggested that the market and the economy were heading into a brutal period.

At the same time, a much respected U.S. columnist and author Bob Ingle had been consistently writing columns relating to the appalling condition of government finances. I had first called Bob in 2006, congratulating him on his perceptive analysis and more importantly the accuracy of his columns. I gave him my forecast as it fit with his view. Bob is a senior political columnist for Gannett Newspapers and co-author of The New York Times’ Best Seller, “The Soprano State: New Jersey’s Culture of Corruption.” Bob has appeared on national television as well, he does his homework to say the least.

Bob has been one of few columnists who address and understand what we are facing. Three years later while driving from Montreal to New York, I heard him being interviewed on a widely listened to radio program.  The program’s host asked Bob as to how long the difficult economic period would continue.  Without mentioning my name, Bob said that someone who had forecast the economic slide (referring to me) had told him that it would last ten years so we had seven more years to go. I hope that the conditions soon change for the better but I doubt it.

IN THE STOCK MARKET, VALUE IS “ALWAYS” AVAILABLE: Whether we are bullish or not, we always are invested and can always find stocks that are very undervalued. To us, opportunities are there for the patient value oriented investor…..We see heavy insider buying in some stocks, not in most stocks but some. Insider (officers and directors) selling in the large cap industrial stocks has been heavy with little buying. Yet, the buying in the mining related stocks has been quite positive.

REQUIRED: The United States Federal Reserve Bank needs the stock market to perform well and we believe is involved in the stock market one way or another. As a leading economic indicator, the Fed does not need nor can it desire a bear market. The economy is weak enough today without a bear market adding to economic woe and weakness. Pension funds have payment requirements every month to pensioners so a positive and liquid stock market is required. The stock market must avoid a bear market at any cost. Key: Bond interest and interest on money funds are insufficient to cover many pensions. Today’s Low interest rates deliver low payments that are inadequate.

INTEREST RATE VULNERABILITY: What should be of great concern is the fact that China owns approximately $3,100,000,000,000 ($3.1 trillion) of US bonds of which $1,300,000,000,000 ($1.3 trillion) that are U.S. Treasury obligations. A mere 1% increase in rates from 2% to 3% in Treasury Notes could create chaos in the bond market as the value of just the $1,300,000,000,000 in China’s Treasury obligations would suffer a drop in value by between $300,000,000,000 to $400,000,000,000 to reflect the higher rates. And it would also damage the US housing market as it would cause an increase of monthly mortgage payments of 20% to 30% for new purchases. That possibility is worrisome.

CYCLES AND TECHNICALS: As we look at valuations and the cyclicals, we still can see the risk of a 20% to 27% decline in the stock market. Nothing has to occur, but we look at history. But why hasn’t the normal 20 % downside occurred during the last two years? Because interest rates are near zero and the key ingredients for a bear market are not in place. Again, bull markets do not end due to overvaluation. They end with interest rates rising often sharply, a decline in the money supply or a recession. Those components of a bear market are not in place, at least yet. Low rates and Central Bank intervention have carried this stock market. Notice what happens when “tapering” is mentioned, the market begins to swoon and talk of tapering seems to stop.