“Yo” – This Market is Set For a Major Correction
Wall Street came to a halt recently, as Chinese e-commerce giant Alibaba made its Initial Public Offering debut. The media became myopically focused over this so-called “historic event” and by its celebrity founder Jack Ma. By the time the closing bell had rung, the hype and fanfare propelled Alibaba up 36 percent on its first day of trading and caused the world’s largest IPO to display a market cap worth $231 billion. The investing public seems to have forgotten the dangers associated with disregarding valuation metrics—Alibaba is trading at a Price to Book value ratio north of 27!
But it’s not just irrational investments, such as Yo, and overhyped IPO’s, that are signaling a top to this market. There are technical indicators in the market that are also setting off loud warning bells. The breadth of the market is troubling to say the least, with nearly 50 percent of stocks in the NASDAQ down more than 20 percent from their peak in the last 12 months. Additionally, more than 40 percent have fallen that much in the Russell 2000 Index. In fact, the Russell 2000 index of smaller companies is now down over 4 percent on the year, and has in technical terms reached a “death cross”. A death cross occurs when a stock or index’s 50-day moving average trend line dips below its 200-day moving average; and is a sign momentum is fading.
It’s clear as the Federal Reserve reins in its economic stimulus plans that the appetite for risk is narrowing. QE III totals $1.7 trillion worth of Treasury and Mortgage Backed Security purchases and this program ends in October. And the Fed’s massive money printing scheme, which resulted in record-low interest rates for the last 6 years, has manifested in stock, real estate and bond bubbles occurring all at the same time.
Regression to Trend: A Perspective on Long-Term Market Performance
The peak in 2000 marked an unprecedented 148% overshooting of the trend — nearly double the overshoot in 1929. The index had been above trend for two decades, with one exception: it dipped about 13% below trend briefly in March of 2009. But at the beginning of October 2014, it is 89% above trend, up from 85% above trend the month before. In sharp contrast, the major troughs of the past saw declines in excess of 50% below the trend. If the current S&P 500 were sitting squarely on the regression, it would be around the 1057 level. If the index should decline over the next few years to a level comparable to previous major bottoms, it would fall to the low 500 range.
Secular Bull and Bear Markets
Ben Graham Corner
Margin of Safety!
Central Concept of Investment for the purchase of Common Stocks.
"The danger to investors lies in concentrating their purchases in the upper levels of the market..."
Stocks compared to bonds:
Earnings Yield Coverage Ratio - [EYC Ratio]
EYC Ratio = [ (1/PE10) x 100] x 1.075] / Bond Rate
1.75 plus: Safe for large lump sums & DCA
1.30 plus: Safe for DCA
1.29 or less: Mid-Point - Hold stocks and purchase bonds.
1.00 or less: Sell stocks - rebalance portfolio - Re-think stock/bond allocation.
Current EYC Ratio: 1.03
As of 10-1-14
PE10 as report by Multpl.com
Bond Rate is the rate as reported by
Vanguard Long-Term Investment-Grade Fund Investor Shares (VWESX)
DCA is Dollar Cost Averaging.
PE10 .........26.14
Bond Rate...3.98%
PE10 .........26.14
Bond Rate...3.98%
Over a ten-year period the typical excess of stock earnings power over bond interest may aggregate 4/3 of the price paid. This figure is sufficient to provide a very real margin of safety--which, under favorable conditions, will prevent or minimize a loss......If the purchases are made at the average level of the market over a span of years, the prices paid should carry with them assurance of an adequate margin of safety. The danger to investors lies in concentrating their purchases in the upper levels of the market.....
DYI
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