October 20, 1999: I am at a breakfast briefing run by a British investment house. Scarfing my bacon bap and croissant, washed down with the treacly and malodorous coffee that only hotels can provide, I feel quite the patronised lower-order businessman as I listen to the market overview.
Suddenly, I become uneasy. It's not the stomach registering the high fat food - nothing like it for dealing with last night's alcohol, I find - it's the strange disconnection between what the fund reps are telling me and what they want me to do. They are feeding me dead pig so I will recommend equity investment to my clients - but they're telling me (with relaxed smiles) "the American stock market could be as much as 50% too high, and a correction is overdue", as I reported in a letter to a client the next day.
We sure get bought cheaply, don't we?
It was around the same time that I attended a monthly broker network meeting in Worcester, where another fund house recruiting sergeant told us IFA doughboys how (in 1999) the tech boom was only in its first phase, and a sort of super-boom was coming next.
That's when I decided (1) to start reminding my people that most of their pensions and investments had an option to switch to cash within the wrapper - with the caveat that I had no crystal ball, and (2) to change my own business and earnings model to survival mode.
The next year, when one of our colleagues at the monthly get-together revealed that the best asset class for the last 12 months had been cash and asked hands up who'd seen that coming, I kept my hand down. I didn't want to disappear in a hail of slightly stale bread rolls.
Today I read in "The Spectator" magazine an article by Merryn Somerset Webb, editor-in-chief of "Moneyweek". She points out the inflationary boom in the East and suggests a contrarian play - invest West (counting Japan as part of the West) - but warns of overvaluation here, too:
"I refer you to two valuation measures that seek to tell us where markets will go over ten to 20 years, the cyclically adjusted price-earnings ratio and the Q ratio of market value to underlying asset value. According to their biggest fan, the strategist Andrew Smithers, they now tell us that the US market is around 70 per cent overvalued."
I fear that Smithers is an optimist; or rather, when he says a market is overvalued, I assume he's using a theoretical fair value as his point of reference, and ignoring the overshoot effect. 70% overvaluation implies a 40% (ish) drop; but for a long time I've been watching for a 70% drop.
Back in October 2008, J. Kyle Bass of Hayman Advisors (.pdf here) was saying "We think we will see 10-12% unemployment, a 4-5% decline in GDP, and the equity markets could drop at least 70% from peak to trough." (I love that reassuringly conservative "at least", don't you? As Wavy Gravy said at Woodstock, "There is always a little bit of heaven in a disaster area." Maybe we will all be feeding each other again, man.)
So I had a go at drawing a picture... in December 2008, I took the Dow at close at the start of each calendar month from late October 1928 to 80 years later, and divided it by inflation (CPI-U) as announced for the end of the preceding month (I figured that even official figures for consumer prices aren't as manipulated as the gold market). Here's what I got:
Re-done today to the end of January, here's the same story updated:
Read this way, the real peak was at the end of 1999, then the market halved until monetary inflation from 2003 blew up real estate, then it halved again until the wonders of QE, and sometime soon the Fed's lungs are going to give out once more.
Allowing for inflation, a drop of 70% from December 1999 would mean the Dow's low should be just under 4,500 today. That red dot really doesn't look so freakishly out of whack in context - not half so much as the Twin Peaks before it.
Of course, inflation is the joker in the pack. I'm talking about a deflation of the Dow in real terms; one way that could happen is a phoney boom discounted by high inflation - like 1973 - 1982, for instance:
It took until April 1992 for the real Dow to get back to what it had been worth in December 1972; but at least it got back. The dollar lost 70% of its consumer purchasing power over the same period.
Like I said in my last SA article (This Liquidity Will Soak Us All ), it may be that we're going to wet, no matter what tree we stand under.
Meantime, I'm buying my own sandwiches.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.