Only a few times, in the 1950s and in the 1990s, has the Dow’s one-year Sharpe ratio been as high as it has been this week. (Mr. Deluard calculated it by dividing the Dow's one-year return by its annualized standard deviation).
. . .
Ultra-high Dow Sharpe ratios haven’t lasted long historically, suggesting that the market is due for choppier trading ahead.
Friday, October 27, 2017
The Year Stocks Stopped Being Risky - What About The Year After?
When the happy-talk starts to dominate, perhaps we should be headed for shelter.
A recent article in the Wall Street Journal argues that stocks are no longer "risky" due to some metric which divides gains by volatility - the so-called Shape ratio. Of course, with big gains, you have a high ratio. So we have big gains this year, but of course, every bull market is followed by a bear one.
And today's bull market might not last long in an era of economic uncertainty, high interest rates, and stagnant wages. If Trump's tax reform falls flat (after his stunning victories in immigration reform, repealing Obamacare, and building the wall) the market may tank. I suspect the market is set for a correction.
People point to stellar profit reports this quarter, but even though Amazon is finally making a profit, its P/E ratio is a staggering 511. And as for Apple, do you really think the majority of Americans can afford a $1000 cell phone or will camp out overnight to get one? I am skeptical to say the least.
The article, after cheerleading for stocks for many paragraphs, closes with these two cryptic comments:
Yes, in the 1950's the ratio was high and the economy boomed. Everyone bought cars with fantastic chrome and tail fins. Then 1958 happened, and people started buying stripped Ford Falcons instead. It's called a recession and they happen with regularity. The 1990's were a boom time as well, followed by a recession in the 2000's.
Now, granted, over time, the bulls beat the bears. Even the dramatic recession of 2008 was followed by nearly a decade of solid growth, which is where we are today. Over time, even if you just hang on to stocks, you will do well, even with "corrections" now and again.
In my lifetime, I have seen a number of these sort of events, either taking over the entire market, or merely affecting segments of it. Car sales boom all at once, and everyone buys a new car. Then they tank for a few years, until the cars bought eight years ago start to wear out and the cycle starts again.
Housing goes nuts and costs escalate, until people stop buying, then the market collapses. Sometimes, this just affects housing prices (as in 1989) while other times, it takes out the larger market (2008).
That we are due for a correction is not debatable. It is not a matter of "if" but "when" and timing the market is very hard to do. You can look at a lot of metrics and try to figure out a formula, but I think that is tricky. Myself, I go by the happy-talk index. When people start saying nonsense like "buy now or get priced out of the market forever!" then you know something bad is going to happen.
There are a lot of stocks doing very well right now, and corporate profits in some sectors are way up. But in some tech stocks, the prices don't reflect a rational valuation. Yes, Amazon is doing well. No, the stock price is not rational at a P/E ratio of 500. Who wants to wait 500 years to earn their money back?
Other stocks, not so good. Twitter, the President's favorite website, continues to lose money, although they claim they "may" turn a profit this quarter (someone needs to update the P/E charts, which still show a negative 600 ratio for 2018!). Even if they manage to pull a rabbit out of the hat, like Amazon, they are horrifically over-valued. Correction will happen, just wait for it.
Other companies are doing less well. Toys R Us is going bankrupt, and perhaps 2018 will be (finally) the year Sears/K-mart collapses. While CVS claims to be buying health insurance company Aetna, Walgreens is closing a number of stores (I guess CVS won the corner drugstore wars).
Meanwhile, the US car makers are doubling-down their bets on trucks and SUVs - killing off their car lines (As Chrysler did before the recession of 2008 - going to an all-SUV lineup, and we know how that worked out). Meanwhile, oil prices creep up and the President wants to raise the gas tax (which is actually a good idea). One war in the Middle East, or shutting off the Iran oil flow, and we're back to $100 a gallon, which is a good thing, as some oil companies are barely breaking even these days.
This is a hot stock market, to be sure. But I don't see a lot of depth to it - any long-term stability. The recovery has been fragile, based on slow, steady growth and a zero percent interest monetary policy (and even negative interest!). All that is going to change, no matter who Trump appoints to the Fed.
Will we see a huge crash? I don't think so, at least not in the near-term. Housing prices are high again, but we are not seeing the spectacular double-digit increases we saw in 1988 or 2007, except in some hot markets. If the correction is soon, I think it will be managable.
On the other hand, if we enter a new era of Trump euphoria, where the market decides that deregulation, tax reform, and other changes merit even larger increases in stock prices, the resultant bubble burst will be even worse.
Myself, I have been quietly liquidating some stocks and mutual funds, selling off portions of things that have done spectacularly well in recent months. Better to lock in the profits than to ride it all the way down. And at this point in my life, I am going from working, earning, saving, and investing, to spending. So there is little upside to me keeping money in stocks as I get older and older.
We'll see what happens. But this article in the WSJ has me worried. Seems like a lot of happy-talk to me!
UPDATE: Apple claims that sales of the new iPhone x are "off the charts" but fails to say what those charts are or provide any quantitative numbers as to how many have been pre-ordered. Given that it appears the facial recognition feature hasn't been completely debugged yet, Apple's coyness is understandable.