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Herb Morgan (Efficient Market Advisors, LLC) submits: Last November I published two articles on the Seeking Alpha Network in the ETF Investor section, both of which generated a nice bit of response from readers and fellow contributors.

In the first article titled “Energy Prices vs. Earnings, or Godzilla vs. King Kong,” I pointed to the fact that CPI increases did not correlate with stock price decreases. As a refresher, I published the following table in that article:

Worst inflation (CPI ex Food & Energy NSA) years since 1979:
Year CPI S&P500 Russell 1000
1980 12.15% 32.50% 31.87%
1979 11.32% 18.61% 22.33%

I looked at years with the largest CPI increases and the largest stock price decreases and found no historical correlation between the two.

In the second article titled “Dow 15,000," I stated that stock prices as measured by the DJIA would rise substantially, to 15,000.

As of Wednesday night’s close (5/17/2006) the DJIA stands at 11,205 vs. 10,805 on November 30, 2005, representing a 3.7% advance. Add dividends to the picture, annualize and voila, you get the magical historical mean return for stock prices. The reason for the recent sell off in stocks is twofold in my opinion:

• Earnings season is over, resulting in the need for a “fix” for the trading addicts among us. They need something else to justify the impulses of their nervous energy.

• The drug of choice for those with the incessant need to increase the velocity of investor money varies, seemingly with each passing week, but for now they seem fixated on the Fed’s unwillingness to lay out their exact plans for all to see. Anything to justify the two and twenty, I say.

In about fifty calendar days we will once again be in earnings season. I suspect numbers will be stellar across the board, dividends will be increased, and shares will be repurchased, which will ultimately lead to higher equity prices.

The need to trade, like a junkie’s need to a fix, is more often detrimental to one’s investment returns than not and I predict those managers who are chock full of energy, oil and gold (Oh My!) will suffer the same fate as the geniuses of March 2000. March 2000, for those who were still backpacking around the MBA program, was a period in which the following seemed resolutely true:

• It was different this time

• Companies with a power point presentation could get VC funding and go public in three months without ever making or selling anything to anybody.
o Their stock doubled in three days

The last pessimist had become an optimist

• Moore’s Law usurped the Law of Gravity and Common Sense

Not wishing to embarrass anybody who is trying to reinvent themselves professionally, I can assure readers that the gurus and geniuses of March 2000 whose mutual funds and separate accounts had boasted returns in the triple digits are without exception, not the gurus of today.

In the short run of course, anything is possible as securities prices gyrate wildly whilst reverting to their true value in an efficiently priced market. So in the short run let’s examine the universal truths of May 2006 (with tongue firmly planted in cheek):

• It is different this time

• Any commodity based ETF can go public and raise a billion dollars in three months

• Commodities can only rise in price, especially:
o Oil
o Gold
Wasn’t it just two short years ago that we were all crying deflation?

• There are no more bears on Oil, Gold or any commodity that now trades as an ETF

• Interest rates are going substantially higher despite the lack of credible data pointing to real inflation

The last pessimist has become an optimist

Barring any external shock, I suspect we will look back on 2006 as a Goldilocks type of year. In an environment of real inflation (i.e. a decline in the value of money), bonds would be plummeting and interest rates would be rising at a rapid clip. The value of stocks is driven by earnings and interest rates. Both seem to be moving in a direction that favors equity ownership.

Today, I have published my treatise on market fads and other historically poor investment decisions entitled “Good Money – Bad Investments”. The booklet is thirty three pages and contains the lessons of nineteen years in this business. If you’d like a copy, give us a click at www.etfaccount.com or call 888-327-4600.

Source: How to Identify a Market Top: When the Last Pessimist Becomes an Optimist