Richard Russell on valuations
I have
written in the past that I am very skeptical as to the yardsticks used in order
to determine values. Among many reasons, I believe that using a fixed figure
like PER>20 “expensive” is self-defeating as the total capital stock of the economy changes and
the underlying rate of discount changes too. This is why “value” measures of
the cheapness or dearness of the stock market have failed miserably since the
last 20 years.
I feel that
any value measure should be “relative” to recent readings, thus
reflecting the contemporary situation of our economy (and the capital stock,
which indirectly has some bearing on the rate of discount). It makes no sense
comparing PER readings of the roaring twenties with PERs of the twenty-first
century. Any value measure should be relative to the more or less recent past.
Hence, I like
and I find elegant the way Richard Russell, of the “Dow Theory Letters” has
found to conclude that stocks are expensive now:
“Current
P/E divided by the average P/E of the preceding decade. We are now 53.3% above
the average P/E of the preceding decade. There have been only three times when
valuations calculated by this method were higher -- the late 1920s, the late
1950s and 2007 just before the bull market ended. Judging from current
valuations, we are either near the beginning of a bear market -- or facing a
decade of sub-par performance from stocks.”
Russell's measure
makes sense, since we are just comparing our current PER with the average PER
of the preceding decade. This makes more sense. The economy may change in ten
years, but, nonetheless, it will be more similar to the PER readings found 100
years ago. Thus, in a very buoyant economy a PER of 20 might not be “expensive”
if the average of the last 10 years has been 19.
Accordingly,
I feel that Russell’s measure might be right, and I feel that stocks are priced
for perfection.
So, what
should we do as investors?
1)
We should bear in mind that value considerations are important when investing
along the secular trend (which may last more than 10 years). However, those
concerned with the primary trend (which lasts significantly less, let’s say
between 1-2 years), should not be put off by the dearness and cheapness of the
stock market.
2)
I am not a fool, and I know that after five years of advancing prices, the
market is more susceptible to a secular bear market. Furthermore, and I agree
with Russell, we are not seeing a “bargain” market. However, I also know that
nobody knows when this primary bull market will end. And I also do know that
the classical (and even better, Schannep’s) Dow Theory will signal soon enough
(let’s say ca. 10% below the market top) when it’s time to run for the exits.
3)
Accordingly, even though I like to know where I stand, as far as valuations are
concerned, I know that I will not act on this information.
4)
However, if I were a secular investor, I would definitely run for the exits, as
my investment decisions would be based on values and not on technically-based “timing”.
5)
Please bear in mind that market pundits have been complaining that the market
has been expensive for a long time now. However, the market impervious to such
warnings continued to make higher highs, and those value-based investors were
left on the sidelines (Richard Russell, included). While certainly this bull
market run will eventually run out of gas, we don’t know when will it happen.
Personally, I prefer the following technically based wager: I have open ended
profits (as nobody knows whether the markets will still advance +10, +20 or
even +40%) against a likely loss of -10%, should the markets start to fall in
earnest right now (-10% is the most likely loss from the top as per past
primary bear market signals).
Let’s turn on
to the markets.
US Stocks
The SPY and
Industrials closed up. All three indeces exceeded the last recorded closing
highs, which is bullish.
The primary trend was reconfirmed as
bullish on October 17th, 2013, and November 13th, 2013 and March
7th, 2014, for the reasons given here, here and here.
So the
current primary bull market signal has survived three secondary reactions.
Gold and
Silver
SLV, and GLD
closed up. For the reasons I explained here,
and more recently here the primary trend remains
bearish.
For the
primary trend to turn bullish, SLV and GLD should jointly break above the secondary (bullish) reaction highs. As a
reminder, the secondary reaction closing highs were made on August 27th,
2013. From such highs the market declined without jointly violating the June 27th,
2013 primary bear market lows.
Here I
analyzed the primary bear market signal given on December 20, 2012. The primary
trend was reconfirmed bearish, as explained here. The
secondary trend is bullish (secondary reaction against the primary bearish
trend), as explained here.
On a
statistical basis the primary bear market for GLD and SLV is getting old. More
than one year since the bear market signal was flashed has elapsed. However, I
am extremely skeptical as to the predictive power of statistics. I prefer price
action to guide me, and the Dow Theory tells me that the primary trend remains
bearish until reversed.
Furthermore,
the June 27, 2013 lows remain untouched. The longer this situation lasts, the
higher the odds that something might be changing. But I wait
for the verdict of price action.
As to the gold and silver miners ETFs, SIL,
and GDX closed up.
I profusely
explained that SIL and GDX set up for a primary bull market signal. You can
find all the relevant information from a Dow Theory standpoint here.
Please mind
that a setup is not the real thing. So the primary trend has not turned bullish
yet (or maybe “never”).
The secondary
trend is bullish, as explained here.
In spite of short term bullish accomplishments, SIL and GDX are not in a
primary bull market.
The primary
trend for SIL and GDX remains, nonetheless, bearish, as was profusely
explained here and here.
The secondary
trend is bullish, as explained here. In spite of short
term bullish accomplishments, SIL and GDX are not in a primary bull market.
The primary
trend for SIL and GDX remains, nonetheless, bearish, as was profusely
explained here and here.
Sincerely,
The Dow
Theorist
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