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Gary Jakacky
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Welcome back, Seeking Alpha. I am glad to be back from a six month bicycle tour throughout the Pacific Northwest in the USA and Canada. It often helps to take a breather from the markets and hub-bub of Wall Street: while I was enjoying the fields, forests, and parks of this great nation, stock... More
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  • Don't Pay Attention To 'Profits As % Of GDP'

    Why not? Because over the long haul--- the time frame over which the biggest profits are made---there is no relationship between corporate profits as a % of GDP, and the behavior of a broad index of stock prices.

    Lets look at the evidence. Below is a chart showing profits as a percentage of GDP in the Post WWII era.

    (click to enlarge)

    As a statistician and analyst, when I look at this chart, I see four periods of time where profit margins fell noticeably and for prolonged periods:

    • 1951 to 1954, which was part of a general post WWII decline in profitability that persisted throughout that decade;
    • 1965 to 1971, perhaps due to the effects of the Vietnam War, inflationary pressures and surtaxes,
    • 1979 to 1986, perhaps due to tight money in the emerging Volcker era, and
    • 1996 to 2000, perhaps due to globalization and opening of third world markets.

    Sure there were other zigs and zags, but these are the big ones which stand out.

    Now lets compare these four lengthy intervals of punk profits with performance of the Standard and Poors 500 Index over these same time periods. You will want to enlarge the chart so you can see the selected periods I talk about.

    • 1951-1955: During these years corporate profits were sliced in half! Yet look at Standard and Poors index during this period..almost a steady advance, except for a few down months in 1953. (I was born in 1953...as good an explanation for the selloff as any!) If you prefer the Dow Jones Industrials figures, the index climbed from 200 to almost 500 over this span. Nice work, if you can get it, as Gershwin would say.

    (click to enlarge)

    By the way, the pattern thru the rest of the fifties continued to show no relationship. An investor in those Eisenhower years who was waiting for profits to return to their postwar peak sat out two powerful bull markets from that era! So did investors who were pining for traditional blue chip dividend yields...but that is a topic for another article.

    • 1965-1971: The lesson here is similar to that of the previous decade. Profits slumped to postwar lows, and yes, the overall performance during this period was poor. But investors focusing strictly on profits missed a 2 year bull market from 1966 to 1968.

    On the other hand, profits surged in the early to middle 1970s. But what did investors have to show for it? Those years were no kinder to investors than the previous 6 years had been! Stock prices hit 20 year lows in late 1974, even though profits as a % of GDP were still higher than a few years earlier.

    • 1979-1986: this is my favorite example and half the reason I wrote this article. In this 'Volcker era,' profits fell steadily to what appears to be (from our vantage point) generational lows. Yet, over this time span prices broke out of their fourteen year consolidation and soared to new highs as inflation and double digit interest rates were tamed.

    Much like the 1950s, there was a bear market in the early Reagan years, in this case as monetary discipline bit the economy; but once this was over it was full steam ahead, even as profits continued to fall!

    • 1996-2000: I have chosen to save the best for last. Please don't tell me I have to tell you what happened to stock prices in this period! Profits as a % of GDP went straight down...and stock prices went, um....straight up. Et tu, Nasdaq and countless world indices.

    Now, some will claim that it is the extremes in margins which should attract your attention for investment purposes. I do not disagree with this view, but i wish to point out that these extremes come so far apart that even a long term investor could wait decades before a position should be taken.

    For example, the 1950s peak was not surpassed until 2006! Please show me someone who went this entire time without selling.

    And how many investors are going to wait for the 1984 trough before buying stocks again?

    There are many factors which affect stock prices: interest rates, debt levels, technological breakthroughs, political events, secular trends in PE ratios and other multiples, etc. A singular focus on profits can be disastrously simplistic for the long term investor.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Additional disclosure: Always pays off to be long term bullish!

    Aug 21 3:38 PM | Link | Comment!
  • Logarithmic Charts Should Be The 'Apple' Of Your Eye.

    Odds are you haven't used logarithms since your teacher introduced them to you in high school mathematics, if you can remember back that far. But for investors who count on price charts to gauge stock performance and use technical analysis, logarithmic charts are an essential tool that must be understood.

    There are two basic scales for price on the vertical axis in stock charts: a linear scale, and the logarithmic scale. A linear scale assigns equal vertical distances to dollar changes in price; a logarithmic scale assigns equal vertical distances to percentage changes in price. This is not a small detail long term investors can overlook. Since it is percentage gains which investors use to gauge performance, the latter scale should be used in many cases.

    Consider the two charts below which show the price of Apple Computer, one of Wall Street's darlings for the last decade. The top chart is a linear scale, the bottom chart a logarithmic one.

    (click to enlarge)

    The chart clearly shows that AAPL was a superb investment over this period. What catches your eye immediately are not only the surge in price that began after the 2009 crash, but also the huge spike in the last six months or so. In contrast, AAPL sure looked like a boring holding through most of 2002 to 2005!

    But looks are deceiving, as the logarithmic chart below makes clear.

    (click to enlarge)

    It turns out the surge from $6 a share to $200 a share in the previous decade was far more important and profitable to investors than the recent strength after the crash. And that pop in 2012? It looks almost insignificant relative to some past action. Yet how many investors would boast about the huge price increase in AAPL since the beginning of this year?

    On a logarithmic chart, a price change from 2 to 4, from 20 to 40, or from 200 to 400, all have the same "size" on the vertical axis: and thus the investor is not deceived by the large $ amount of the latter change.

    Logarithmic scales have other advantages as well. On the linear chart, it is impossible to imagine drawing a trendline connecting the series of lows in 2003 on up through 2008. In contrast, on the log chart, a trendline connecting 2003 and 2006 lows is very meaningful: it was touched in 2008 and broke later that year, showing just how significant the 2008 financial crisis was. Similarly, on the linear chart the 2012 surge has made a trendline connecting dips of the last few years hopelessly out of touch. In contrast, on the logarithmic chart that trendline very much in play as a source of support or a matter of concern were it to break.

    All this is not to say that there is no place for linear price charts. But their use should be confined to short periods of time, to narrow fluctuations in price, or both.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Aug 10 1:34 PM | Link | Comment!
  • Dow Theory And The Bull Market's Second (Ongoing) Test

    In articles I and II I outlined the principles of Dow theory and applied it to the market's action since, in my analysis, a Bull Market was signaled by action of the Industrials (DIA) and Transportation(IYT) averages in the spring of 2009. Dow Theory tells the investor to assume the bull market is ongoing until the following happens:

    • a secondary reaction of meaningful extent and duration occurs;
    • prices recover briefly and attempt to reach new highs;
    • the attempt fails and new local lows are set in both averages.

    We used these principles in arguing that the market gyrations in the summer of 2010 did not constitute a bear market signal.

    What about the market action in spring through early fall of 2011? In my opinion, a bear market was signaled and then almost immediately reversed. Why do I say this? First, look at the Industrials over this period.

    (click to enlarge)

    Notice the selloff from late April to late June. It clearly met time and extent requirements. The rally into July failed to set a new high and the summer collapse took prices to new lows. Thus the Industrials suggested a bear market had started. What about the Transports?

    (click to enlarge)

    The Transport selloff was a bit shakier in terms of extent; and prices, in fact, did recover to new highs in July while the DIA did not. I gave the DIA the benefit of the doubt and when prices collapsed to new IYT lows in July that average had 'confirmed' that a bear market was in progress. It sure felt like one! The numerous sharp selloffs into the fall seemed to fit the scenario as well.

    But what happened in the next few months? The surge in October was clearly a secondary reaction (rally) against the now prevailing bear market, and when prices marked time in November and December before going to new local highs in both averages just before Christmas, a new bull market had again been signaled. What do we make of this?

    Keep in mind the Dow Theory is designed to keep us on the side of a major long term trend. Bear markets do not last for 5 weeks; bull markets do not last 5 weeks..They are long term events related to economic and business developments. Thus, with the advantage of hindsight, it is better to just rewrite the entire selloff in the summer of 2011 as one single secondary reaction against the bull market that began in the Spring of 2009.

    Where does this bring us? The Industrials have, since, rallied to a new local high in February of 2012. So the Industrials have confirmed the ongoing bull market, now over 3 years old. But, notice the transports have not rallied above their July 2011 high of 100. Thus, the transports have not confirmed the bull market....yet. Under dow theory principles, we should assume the bull market is still in progress; but there is now some doubt.

    In order to confirm the Bull market the transports must surpass last summer's highs! We've been waiting a LONG time. But in dow theory such periods do, indeed occur, and they call for patience on the part of investors.

    I might add that some analysts believe a bear market was signaled this past May when the Industrials touched a high for the year, IYT did not, and then both indexes sold off. In my opinion these gyrations in SPY and IYT were not substantive enough, or lengthy enough, to be classified as secondary reactions. So I disagree with this view, although the continued punkiness of the Transportation average is a matter of concern to long term investors.

    Disclosure: I am long SPY, DIA.

    Aug 09 1:45 PM | Link | 2 Comments
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