Author: Michael Douville
Everything is Absolutely Awesome! Business is Great! The 2017 Christmas sales were a record according to Visa/MasterCard; (the fact that the Charge Card Companies have record sales is a sign in itself). Everyone extrapolates this feeling of Euphoria to continue next year and the years following; the Top always feel this way! In 2006, I counseled my clients to take profits after the extraordinary year of 2005; my forecast for the direction of the Real Estate Market was DOWN! Most of my clients thought I was wrong; I was for 6 long months……
These extravagant markets can continue for longer than one would think possible. Values get stretched and returns shrink and yet the markets continue to rise. No one wants to believe an ending is possible. There are however, harbingers for the watchful and observant.
The Case/Schiller PE ratio is based on inflation adjusted earnings over a 10 year period. The Index fluctuates, but has averaged 15.21 for many, many years indicating proximately a 6.6% return. When the Index is below 15.21, the index is considered a better value and indicates better than a 6.6% return. The CAPE Index has steadily climbed and is now 32.46 as of Dec 29th 2017. This is exorbitantly high exceeded only by the Dot. Com Bubble which reached the record of 44. The current reading of 32.46 is higher than the 1929 Market Bubble, the 1987 Crash, and the Dec 14, 2007 Stock Market top. Further, the earnings (the E of the P/E ratio) may be terribly distorted as many Fortune 500 companies are quoting non-GAAP earnings which are typically misstated by 10-25% due to the flexibility by company officials as to what constitutes a “profit” and a “loss”. Widespread use of non-GAAP earnings could easily drive the “Real” P/E to well over 45. This valuation can remain elevated much longer than one would expect much like the prior Real Estate Bubble. You can believe this: the Stock Market Cycle will end and when the Cycle completes, the market will need to fall at least 50% to get to normal. The pendulum never stops at “Normal”. Expect an “equal but opposite” reaction to an 80-90% loss. Devastating!
Martin Armstrong has stated Global Interest Rates are at a 5000 year low! Ancient Sumeria had higher rates! Bond prices have an inverse relationship to price. As rates drop, as they have since 1981, the price of bonds rises, The long, long 35 year interest rates cycle is coming to an end and will destroy Bond Portfolios! Not only is there rate risk, but there is a duration risk as well which amplifies the loss: a 10 year bond has a Duration factor of 9. Should there be a 1% increase in rates it results in a 9% loss! Currently, 10 year Treasuries are 2.4% ish….normal could easily be 6%, Over a 30% loss should it “Normalize”; the pendulum swing could go to 12%+! Devastating!
The Interest rate trend line has recently been broken. Higher rates are a high probability based on Technical Analysis. Also, Non performing loans were 6.5% in Europe at the time Lehman collapsed; currently, NPL’s are over 10.5% and Italian banks are reported to have upwards of 14%. On a Fundamental basis, Bonds are at Risk which will cause higher rates, maybe much higher rates. Global Bond buyers learned recently that the European Central Bank has been the main buyer of Sovereign Italian Bonds. Rates have risen quickly in just the last two weeks reflecting the perceived risk in Italy.
You are the Captain of your Destiny and Keeper of your family Wealth! When violent storms are on the Horizon, which ship will you choose to protect the Wealth? A ship named GREED or a ship named FEAR? You do NOT need to be 100% invested at all times. There may even come a time when it is important to PRESERVE your Wealth or as much of it as possible. Neither of these asset classes may be the that LifeBoat!
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