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No Shortage Of Warnings.

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    December 2, 2013

    Investors typically complained after the 2000 bubble burst that no one warned them. At the top the economy was still strong (the recession didn’t begin until 2001). Fed Chairman Greenspan denied the market was in a bubble. Earnings were still positive and corporations were upbeat. Wall Street’s forecasts were for more of the same.

    But of course Wall Street is always bullish. Even during severe bear markets every week of declines is just another buying opportunity to take advantage of the dip.

    But outside of always bullish Wall Street there certainly were warnings in 2000.

    To mention a few:

    None other than Warren Buffett warned in 1999 of an extremely overvalued market that was headed for trouble. In a famous summer gathering of media, technology, and financial leaders in Sun Valley Idaho in July, 1999, Buffett said that contrary to popular opinion there was no “new paradigm, no new era”, that the market was way out of synch with what the economy could produce in the way of corporate earnings. He said, “The next 17-years will be quite unlike the last 17 years. It might not look much better than the dismal 1965-1982 period when the Dow went exactly nowhere.”

    Nobel Prize for Economics winner (2013) Robert Shiller’s book ‘Irrational Exuberance’ appeared in 2000, warning of a substantial bear market in no uncertain terms; “The present stock market displays the classic features of a speculative bubble, sustained largely by investors’ enthusiasm rather than by any consistent estimation of real value.”

    Even in the financial media, which was subsequently criticized for mostly egging on the exuberance of investors, there were warnings.

    Floyd Norris wrote an article in the New York Times on March 31, 2000, publicizing that Nobel Laureate Franco Modigliani was warning that Internet stocks were “very much a bubble” and that the Dow could fall to 8,000 or 9,000. [It fell to 7,425 at its bottom in 2002].

    Kansas City Star columnist Stephen Winn, warned in an article on March 18, 2000, that, “The people who get hurt when today’s stock-market bubble bursts should never complain that they weren’t warned,” going on to quote Warren Buffett and others who feared a market collapse. “The collapse of inflated prices always comes as a terrible shock to those who lose their shirts. The cries are loud and pitiful: Why, oh why, weren’t we told this could happen? But anyone who can’t hear the warnings about today’s speculative frenzy just isn’t listening.”

    In my own 1999 book, Riding the Bear – How to Prosper in the Coming Bear Market, I summed up by saying, “The U.S. stock market has gone for the longest period in its history without a serious bear market to correct the excesses. So, not surprisingly, in the process the excesses have reached never-before-seen extremes.”

    “Put those extremes – high stock valuations, overbought market conditions, record public participation, record allocation of the nation’s wealth to the stock market, and so on – into a pot, add a pinch of reality and allow to simmer a bit longer, and what do you get? It seems clear that it’s not a question of ‘if’, and there’s not much room left for ‘when’, leaving the main question as ‘how much’. . . . The worst bear market since the 1929 crash is right around the corner, and will be at least as severe as the Dow’s 46% decline in the 1973-74 bear”.

    Warnings this time around are growing.

    It remains to be seen how much time investors who are ignoring them, preferring Wall Street’s bullishness and next Fed Chairman Janet Yellen’s assurances that she sees no signs of a bubbles anywhere, have left before reality takes over this time.

    Other voices:

    Robert Shiller: “The current adjusted price/earnings of 25 is quite a bit above the average, which is about 16. But it’s not so much above average that I would disqualify stocks as an investment. . . . . . But I’m starting to get more worried about the market as it keeps going up. When CAPE gets as high as 28, stocks would start to look unattractive.”

    Wall Street Journal, Ahead of the Tape column: “Surging Stocks Don’t Pass The Sniff Test. While the current move lacks many aspects of a bubble, the rally smacks of a rush to buy almost any stock to compensate for the Federal Reserve keeping interest rates so low. The 27% gain in the S&P 500 in 2013 has come even though revenue growth is seen at a little under 2% and earnings growth at 5% for the full year. Investors are simply willing to pay more for each dollar of earnings. There are more-traditional signs of froth, too. The latest Investors Intelligence poll of newsletter writers puts the percentage of bears at 14.4%, the lowest since 1987. And in a sign investors are putting not only their money but also others’ where their mouths are, margin debt as a share of gross domestic product is nearing historical peaks, such as in March 2000.”

    Robert Frank, Yahoo Finance: “According to Spectrum Group’s Millionaire Investor Confidence Index, millionaires are feeling better about the economy, but more skeptical of the stock market. . . . . The number of millionaires saying they do not intend to invest in the coming months reached a three-month high. Those planning to invest in stock mutual funds fell by 5 percent. But the wealthy do plan to keep pouring money into real estate and cash, with each up 7 percent or more. Experts say the wealthy are increasingly worried about the divergence between the market and the economy, and growing talk about a bubble in financial assets.”

    Sam Ro, Business Insiders: “This morning, economist Nouriel Roubini pointed to no less than 17 global housing markets he thinks look bubbly. . . . And bond king Bill Gross tweeted “We should call this “Green Friday” – But be careful of red numbers in 2014. All markets are bubbly.”

    So we have ample warnings. Those listed are but a few of many.

    But should we invest based on them?

    Probably not. But they are a sign of the high risk that has developed.

    We prefer to incorporate technical indicators with the fundamentals, to indicate when a trend has actually reversed.

    Santa Claus rally?

    Mark Hulbert, MarketWatch.com:

    “Do you believe in Santa Claus? Wall Street does — or at least is hoping that you do. Every year around this time, many analysts and brokers begin referring to a “Santa Claus rally” that will propel the market higher.

    Don’t fall for the sales pitch. The stock market’s average performance before Christmas is no better than mediocre. It is only in the last week of December that the market has strong seasonal winds blowing in its sails. . . . .

    Not all experts who refer to a Santa Claus rally equate it with how much the market rises through its December high, though few bother precisely defining what they do mean. But other attempted definitions don’t fare much better. . . . . .

    One that has been used over the years by some of the advisers the Hulbert Financial Digest monitors is based on supposed market strength over the entire period between Thanksgiving and Christmas. Yet the average Dow gain over these few weeks is statistically indistinguishable from how it performs at any other time of year.

    In other words, you shouldn’t let the Christmas season sway you from whatever investment strategy you already were pursuing. . . . . .

    There is one version of the Santa Claus rally that enjoys strong historical support: the last five trading sessions of December and first two of January.

    This year, for example, a trader wishing to capture this rally would buy stocks as of the close on Dec. 23 and sell them at the end of the trading session of Jan. 3.

    Since the Dow was created in 1896, it has gained an average of 1.7% during this seven-trading session period, rising 77% of the time. That is far better than the 0.2% average gain of all other seven-trading-session periods of the calendar.

    Are these heightened odds of success good enough to justify the transaction costs involved in a specific bet on strength over just these seven trading sessions near the turn of the year?

    The answer isn’t clear — especially after you consider short-term capital-gains taxes, brokerage commissions and “bid-ask spreads,” or the gap in price between the price you have to pay when buying a stock and what you get when selling it.”

    To read my weekend newspaper column click here: Market Seasonality and the Fed Are a Powerful Combination

    Images: Flickr (licence attribution)

    About The Author – Sy Harding, Street Smart Report

    Sy Harding publishes the financial website Street Smart Report Online and a free daily Internet blog at Sy’s Free Blog. In 1999 he authored Riding The Bear – How To Prosper In the Coming Bear Market. His latest book is Beat the Market the Easy Way! – Proven Seasonal Strategies Double Market’s Performance!

    It includes our research and analysis on the economy and markets, and provides charts and buy and sell signals on the major market indexes, sectors, bonds, gold, individual stocks and etf’s, including short-sales and ‘inverse’ etf’s.

    It provides two model portfolios as guides. One is based on ourSeasonal Timing Strategy, one on our Market-Timing Strategy.

    In depth updates are provided every Wednesday, with interim ‘hotline’ updates every time we make a trade. An 8-page traditional newsletter Street Smart Report is provided on the website every 3 weeks, in pdf format for viewing or printing out.

    There is the Street Smart School of online technical analysis ‘seminars’,commentaries to keep you ‘street smart’ about Wall Street, and much more.