The Death of Stocks

I'd like to take a step back from the day-to-day gyrations of the unstable and volatile markets to take in the bigger picture. We have, for an entire generation, been indoctrinated of the notion that stocks are the best long term investment. Indeed, a truly massive financial services industry topped by gargantuan brokerages, mutual funds, and hedge funds has grown to incredible size since the 1980s.

In my entire adult lifetime, stocks have done nothing but go up or sideways, and a massive marketing machine has mushroomed to sell that upside. Indeed, it was noted years ago that there are more mutual funds (and hedge funds) than listed stocks. What is the alternative? We were told that cash was trash, steadily losing value to inflation, and bonds were for losers earning a meager few percent per year.

Omitted was the performance of the stock market from the mid 1960s to the early 1980s. Stocks went up and down, but ended up unchanged in nominal terms. On an inflation adjusted basis, stocks lost most of their value. The P/E of the market declined to less than 10. We have, in this past generation, been sold the notion that a stock market priced at a P/E of 15 to 20 was "cheap" or "fairly valued."

An entire generation's wealth has been poured into the purchase of stocks, or the trading of stocks, or the marketing of stocks. A "macrocosm" of the tech bubble and the housing bubble, this generational "blind faith" in the increasing value of stocks is doomed to implode.

The mammoth Wall Street brokerages have imploded, many banks would have failed without socialization, stocks are collapsing and will continue to collapse as they are over-priced and over-owned. There is simply no one left to buy, and less and less money available to buy with, not to mention that the masses already in the market are beginning to head for the exits.

Many of the stock markets' biggest up and down days had previously occurred during the Great Depression, until this year. Within the past month or two, we have had percentage swings and percentage up and down days rivaling those that occurred during the unraveling of another great generational death of stocks, the late 1920s and early 1930s.

This is no coincidence. Like then, margin or leverage was enormous, stocks were over priced and over owned, and it was an article of faith that over the time span of a year or two the value and price of stocks would be higher. Simply put, you were a fool not to be invested in stocks. You were throwing your money away not being in the market.

Such has been the mantra from the financial services industry for the past generation. Perhaps the climax top was the "mainstreaming" of commodities in the mid 2000s. Once pension funds were convinced that the meager returns on stocks and bonds could be augmented with commodities and were swindled into putting a significant percentage of their assets into oil and cotton and lead, the top was in.

Once illegal aliens and folks without jobs or decent credit were given mortgages and car loans and home equity loans and credit card loans, the top was in. Now, as Todd Harrison of Minyanville has been saying, we are into a generational destruction of bad debt, deflation, and asset price decline.

For now, cash is king, until inflation hits. Then one might want to re-evaluate the commodity and currency markets.

Comments

[Atticus:]

Hay don't forget the SEC recklessly giving the the right to margin at 40 times instead of 10 times, the elimination of the uptick rule (July 2007 uptick rule done away with dow at 14000 now at 8500) thanks you SEC and don't forget the new National Market System (NMS) this has been another gem of a decision of the SEC.
Atticus

2008 Oct 19 07:55 AM

[eddie6442:]

Interestingly, since the 1980's emergence of the "massive financial services industry/mutual funds/hedge funds", America has gone from the worlds largest "CREDITOR" nation to the world's largest "DEBTOR".

America & Americans are broke.............well... not all Americans..........

There is a group of folks generally associated with running Wall Street who have become wealthy beyond comprehension............ And where did all their new found wealth come from????
The same "fools" who still think America is a great country and everything will get better, because it always does?????????

Now they seem to think that their eutopia will be in SOCIALISM....... As the saying goes, FOOLS RUSH IN...............

2008 Oct 19 08:09 AM

[investor88:]

You have written a perceptive and wise article Dr O. Hymm, double PhD in science so it little wonder you write clearly with good views. Must agree with most of your conclusions which means cash is king for now but like Todd Harrison we can trade some for "pocket" money.

2008 Oct 19 08:50 AM

[basehitz:]

Market cheerleaders during good times and moderate corrections predominate. CNBC is among the worst but it is the dominant theme. . . until everything goes to hell in a handbasket. Like now. In the last bear market, cheerleaders dominated until summer '02. Then, after a particularly ugly day, Maria interviewed Bill Fleckenstein in the final hour of trade. As usual, he predicted the end of the world. Dow 3000 was becoming a common refrain, even in general conversation. David Tice was a regular. The end was near, but not of civilization as we know if, but the end of the bear market.

That's just how it works. Natural human instinct is to do the exact wrong thing at the exact worst time. That's why we focus on VIX, where the price traders are willing to pay is now in historic high territory. And investor sentiment is now, for as far back as I can find, the worst in history. And this is reflected in the enormous cash hoards of individuals and institutions. Everyone is selling in mass. Well, almost everyone. Insiders are now aggressive buyers. Warren Buffet, a long time US Treasury holder for his personal account is now investing his personal funds. And value players find value everywhere. But sentiment remains awful and investors remain glued to CNBC who NOW, after devastating market losses, bring on a steady stream of pessimist analysts and journalists now feel very confident writing the end is near.

So what will be the catalyst to change public sentiment? Being the natural cynic that I am, I predict that once the Democrats know they have 3 houses locked up in Washington, will send out all their talking heads to flood the airwaves with soothing messages. The bank lending logjam is already starting to thaw. It is critical the aggresive policies continue globally to stay ahead of this. Then, once public sentiment improves and people start spending and lending improves, businesses can again restock their very lean inventories and consumers will begin to return to normal. At that point, the most pessimistic investor sentiment ever will turn to buyers and a flood of buying will be unleashed.

Long term market cycles since the beginning of the century goes like this: 20 year bull markets are followed by very choppy 15 year periods of consonsolidation. Consolidation started in mid-2002, and if history repeats we'll be range bound SPX 800-1500 until 2017. If we solve our long term problems, such as unfunded liabilities, energy, etc., we'll do well. If not, US financial dominance could be coming to an end. Doesn't mean we fade into oblivion, just a smaller player on a bigger world stage.

2008 Oct 19 09:22 AM

[User 281997:]

"In my entire adult lifetime, stocks have done nothing but go up or sideways"


So Dr O. you must be 8 years old ??

2008 Oct 19 10:31 AM

[bearfund:]

Don't buy into the idea that paper money issued by central banks is suddenly a good store of value. It isn't. More and more of it will be printed and, if necessary, handed out for free by the Treasury, until prices and spending return to boom levels. Then, maybe, the central bankers will try to "drain" that "excess liquidity". But no one will want to lend it back to them unless they raise interest rates dramatically - and why should they if they can get an 8% yield on their money elsewhere with little risk? This is not unlike the situation in the late 70s, but with a huge difference: at that time, long-term rates were sky-high because no one wanted Treasuries after a long stretch of serious inflation. Today, long-term yields are extremely low. Any effort to raise rates and drain excess cash would invert the yield curve and set up the banks for more trouble. There is no way out of this. The money supply is expanding, and even if you aren't seeing that money circulate yet, by the time you do it will be too late to rein it in. Hyperinflation is baked into our future economic life.

The best way to avoid being caught up in it is to avoid the use of central bank paper as a store of value. The only real store of value is gold. The bankers' banker himself, J. P. Morgan, even said so, and Alan Greenspan agreed before his conversion to the dark side. About the only worse place to be than cash right now is Treasuries, and the more duration you have the worse off you will be.

I recommend that anyone who is not interested in stocks and corporate bonds today maintain a conservative portfolio consisting of 50% gold, 20% silver, 20% CHF, 5% AAA Munis, 25% dollars, and -20% Treasuries 2015 and later. This will give you plentiful liquidity, a modest yield, no meaningful risk of a margin call, and minimal exposure to the printing binge.

Once the collapse gets under way (it hasn't even begun), you will want to selectively invest your dollars before they become completely worthless. Start covering your shorts when yields reach 10%; I do not expect a default but it's difficult to guess how large players like the Chinese will react when they begin to understand the scope and scale of the printing, so you could easily hang onto half that position to see what happens. Remember, though, you aren't trying to create wealth with this strategy but preserve it, and a 10% profit is pretty small, so don't get greedy. I would suggest buying non-US gold miners with the remaining dollars. Do not under any circumstances buy US companies as their assets are likely to be nationalised and you will receive nothing of value for your investment. Above all else, be sure that your gold and silver holdings are well beyond the reach - preferably even the knowledge - of the gang of thugs known as the US government. This will also be a good time to dump the CHF; it will hold up better than dollars but is sure to take a fearful beating just the same. Unload the Munis if you can (recall that your losses were hedged out by gains shorting the lower-yielding Treasuries), then get out of Dodge. You should at this point have your wealth largely intact and consisting of 60% gold, 25% silver, 15% non-US miners. Find a nice place to retire, sell some the gold and silver for real estate, and invest some in companies well-positioned at the time to grow their business in the aftermath of the greatest economic collapse the world has ever known: the total destruction of the US dollar. Congratulations; you are a survivor.

Or you could be 90% in "cash" and queue up with everyone else in the bread line when the fiction of paper money crumbles. Your choice.

2008 Oct 19 11:09 AM

[notsosmart:]

nobody knows anything.monopoly money is king.LOL.the huge financial industry created legacy fortunes for some but also thousands of jobs around the world.even more indirect jobs(i think its like 6 to 1)such as IT,bars & restaurants,office & communications,etc.so the crooks & scoundrels are in the headlines but many hard working people will be laid off.the taxes they dont pay you & i will have to make up.the unemployment checks they get you & i will finance.the greatness of this country will diminish over time.nothing lasts forever.

2008 Oct 19 11:11 AM

[secmaven:]

Buffet is buying US stocks. How can they lose? His bet is premised on the the US dollar remaining the reserve currency of the world for the indefinite future. Probably for his lifetime which will be cut short by his diet of cherry coke and junk food. After that he does not care.

2008 Oct 19 11:31 AM

[carey_jim:]

Most of the large corporations that are represented in the major indexes are not producing quality products.

We can summarize entire industries with one or two words (sometimes it takes three) and that's not a good sign:

Big Pharma: Vioxx, Viagra and Cisplatin

Fast Food: French Fries and nachos

American Cars: SUVs, Hummers and small trucks for commuting to work.

Computers: Microsoft, Microsoft and Microsoft

Biotech: Avastin

Entertainment: FOX news, Hollywood and the Governor of California

The Health sector: Vitamin E

The Legal sector: What legal sector?

Buy and hold what, Bomb Shelters?

2008 Oct 19 01:02 PM

[whidbey:]

Bless you and keep you. What is next? Art maybe? You are certainly depressed and creative all at once.

2008 Oct 19 01:56 PM

[henarl:]

Dr O: Everything you've written could also apply, almost word for word, to the real estate market. Boom and bust is the natural way of things - learn to live with it.
carey_jim: Great post but you forgot the AMA in the heath sector and the governor of Alaska in the entertainment catagory.

2008 Oct 19 03:01 PM

[Dr. O:]

I turned 21 at the end of 1981. The market ran from 1982 to 2000 and double topped those highs (except the Nasdaq) in 2007.

2008 Oct 19 07:43 PM

[Did U Think...:]

Finally someone gets it. The whole thing is a giant ponzi scheme for gamblers. A giant turd wrapped in a big red bow with tinsel adornments. The market adds no value, it just moves it around. but you were IRRESPONSIBLE if you didn't get in there and gamble with the crowd. Funny thing is that you could have just owned gold for the past 30 years and out performed the market. Also, you could then have sold it on ebay and opted out of the infernal revenue system.

2008 Oct 19 10:16 PM

[HKI:]

Always amazed at what people would say based on the last 3 months. Death of stock? Pick up a history book please. Over the last 200 years, stock is the best performing asset class globally generating the best real returns. Don't take my words for it. Look up some academic research.

And thank you for this headline. This does make me feel we are getting close to the bottom. Just a couple more like this and it is time for the value guys to buy.

2008 Oct 19 11:32 PM

[johnbee:]

Stock indices have always been false in that underperforming stocks are taken off the index and replaced by stocks with good prospects. It's the Alpha stocks that have already reached past their real growth that pension funds and unit trusts only get to invest in and so the chance of upside is not great. Its always been cherry picking that's made the most money by getting into new stocks and concepts at ground floor level.Sadly these will be the most neglected now as caution takes over and new ideas will be stifled for want of investment.The banks only ever lend money to small business men if they have collateral. They prefer to lend to big corporations as the responsbility is seen to less if a big guy goies under than a small one. Capitalism has been done a very bad turn by so called investment bankers who only know how to rig markets.

2008 Oct 20 10:45 AM

[Dr. O:]

So far this article appears prescient, if I do say so myself. Now if I could only get my money out of the Reserve Money Market Fund.

2008 Nov 06 03:19 PM