Fundamentalanalyse - Dow auf 4000 und 17 Jahre seitwärts?

verfasst von R.Deutsch, 23.03.2002, 11:24

3/22 Adam Hamilton - Curse of the Dow Trading Range

Curse of the Dow Trading Range

In our current hectic and somewhat surreal financial markets, most market participants
today seem to believe that “the long-term” is only about six months out or so.

Corporate managers in the US now maintain an almost fanatical zeal for being
hyper-focused on the current quarter’s results. Wall Street analysts revel in spending
vast amounts of time trying to prophesy those same current quarterly earnings.
Meanwhile, the financial media spends endless hours dissecting minute-by-minute
movements in the major US equity indices. Intra-day stock charts are prominently
paraded constantly on Bubblevision, but when was the last time you saw a five-year
stock chart presented on television?

We are traveling through a peculiar era of history dominated by what could be called the
Cult of the Short-Term. The Cult of the Short-Term has grown so omnipotent these days
that if one dares to challenge its orthodoxy by uttering words about market events more
than six months away they run the risk of being labeled a stark raving lunatic by the
investing masses.

In a wonderful break from the phalanx of short-term data with which we are continually
bombarded, I am blessed right now with the great pleasure of reading Adam Smith’s
incredible classic “An Inquiry into the Nature and Causes of the Wealth of Nations”.
Adam Smith of course was the legendary Scottish philosopher who is universally
regarded as the very founder of the disciplined study of modern free-market economics.
Smith published “The Wealth of Nations” in 1776, a glorious year for the advancement
of freedom on many fronts, disregarding Adam Weishaupt’s maniacal ravings.

The phenomenal wisdom that Adam Smith lays down in “The Wealth of Nations” is
breathtaking. He thoroughly explores the fantastic blessings that true economic freedom
can unleash for people and nations. He discusses the magnificent power of the
specialization of labor and how individuals working for their own best self-interests
provide the ultimate way to fairly allocate scarce resources and raise the general wealth
of everyone in a nation. Smith talks about the crucial functions of free markets and the
international implications of laissez-faire free-market economics. His seminal work
established economics as a dedicated branch of study and in a very real sense
launched the wonderfully liberating economic doctrine of free enterprise.

As I read and attempt to absorb the vast wisdom of Adam Smith handed down through
the ages, I am struck with how long-term his focus truly is. Today, few market
participants can even be bothered with using six months of data to draw their
conclusions about the markets. Adam Smith, however, taking the invaluable strategic
long-view, used six-hundred YEARS of historical data to buttress his points and define
his immortal free-market theories!

Just as today, in Adam Smith’s time there no doubt existed a powerful industry of hype
based solely around selling stocks to suckers regardless of underlying fundamentals.
The notorious South Sea Bubble speculative mania had run its disastrous course in
England about 55 years before Smith published “The Wealth of Nations”. Taking into
account Russian genius Nikolai Kondratieff’s later work illuminating great market cycles
of roughly 60 years in length, another speculative mania was probably brewing in
London when Smith’s wisdom was published.

Smith, unlike the contemporary equivalent of the Wall Street propaganda teams of the
age, the London “stock-jobbers”, focused almost exclusively on the strategic long-term in
defining his powerful theories. He wrote extensively about how capital will only be
deployed by rational investors if they can achieve reasonable earnings and profits with
their capital. In today’s lexicon, Smith sounded like a hardcore fundamental value
investor like Warren Buffet.

Provocatively, centuries later we all remember the brilliant genius of Adam Smith and his
careful methodical analytical approach which included using six-hundred years of data to
help define his wonderful free-market economic theories. Yet, today no one even
remembers the names of the stock hypesters of the era, the conmen like the folks on
Bubblevision today that gleefully spit in the face of fundamentals, logic, and long-term
analysis.

Adam Smith’s prudent strategic focus helped form the powerful ideas that made him a
legend. I suspect that there is not a single serious economics textbook on earth today
that fails to mention Smith’s ground-breaking work!

Unlike Smith’s carefully reasoned prose, today’s rampant Cult of the Short-Term is
immensely dysfunctional and it will ultimately cost naïve investors vast amounts of
capital. Today, just as in March 2000, people are once again uttering nonsense claiming
that earnings and fundamentals don’t matter for stocks. They are once again brazenly
claiming that valuation is irrelevant in our brave “New Era”. The percentage of bulls
versus bears is approaching an all-time high once again. Adam Smith would have
laughed at the folly!

These same perma-bulls have lately been zealously proclaiming that the Dow Jones
Industrial Average is locked comfortably in a new trading range. They don’t consider this
anything to be concerned about of course, as they perceive the trading range as merely
a temporary mustering point on the way to a vast new bull market in equities.

Looking at the current Dow 30 trading range when only a few months of history are
considered is not very enlightening. Yet, what if the trading range of the DJIA is viewed
through the objective lens of longer history? What hard lessons regarding Dow trading
ranges have investors had to learn through much bloodshed and tears in the recent
past? Can we avoid the dangerous pitfalls that wounded the investors before us by
learning from their errors?

Unlike Adam Smith’s impressive six centuries of historical data, we only need about 66
years of historical Dow 30 data to craft this essay. In today’s investment world
dominated by the fanatical Cult of the Short-Term, 66 years may seem like a very long
time, but the great Adam Smith probably would have considered it barely acceptable for
a meaningful strategic analysis.

The perma-bulls today seem to blissfully believe that the Dow trading range is a blessing
heralding a rapidly approaching new bull market. Are they right? Or is the current Dow
trading range really a vicious curse that will ultimately exact far more than its pound of
flesh from unwary investors?

Can the past be useful in defining a probable course for future market direction? Does
history repeat itself in the financial-market arena? If history indeed can be useful for
handicapping the future, what are the potential implications of the Dow 30’s current
trading range in light of hard historical data?

To begin, we will attempt to deploy Adam Smith’s time-tested methodology of using
rock-solid historical data to build a logical point of embarkation. The data in this essay
was largely drawn from our earlier “Century of the Dow” essay that outlined, among other
things, the amazing symmetrical continuum between the past, present, and future in the
world’s premier stock index. In “Century of the Dow”, two major strategic market truths
became readily apparent.

First, major bull and bear markets tend to each run for roughly 17 years or so in the last
hundred years of Dow Jones Industrial Average action. Check out our second graph in
“Century of the Dow” for an illustration of this phenomenon.

Second, the 20th century can be divided into uncannily comparable thirds in terms of
stock market behavior. In these 33-year cycles (roughly double the 17-year bull or bear
cycles), the first half is always defined by sideways choppy trading while the great bull
markets don’t erupt until the second half. The last three graphs in “Century of the Dow”
illustrate this point. Just as Nikolai Kondratieff indirectly predicted, every other bull/bear
cycle ends in a speculative mania, roughly every 66 years (two 33-year cycles), but the
mid-Kondratieff wave bull market can also be incredibly compelling even though it
doesn’t balloon into a speculative mania.

Our first graph compares the most recent two 33-year cycles of Dow 30 action in the
US. The DJIA daily closing price from 1968-2001, the second-half of which produced
the last great bull market we are all familiar with since 1982, is plotted next to the DJIA
daily closing price from 1936-1969.

The price-to-earnings ratios shown at specific points in history in this essay, however,
are not Dow 30 P/E ratios but broad market S&P Composite P/E ratios. The S&P
Composite usually accounts for 85%+ of the total market capitalization of all US equities
so its P/E is a great broad-market measure of overall US stock market valuation. By
comparing Dow 30 closing data with broad-market P/Es, we can gain a strategic
understanding of how the DJIA performs relative to general current stock market over or
undervaluation.

In the graph below, note the incredible symmetry of the behavior of the DJIA over the two
most-recent 33-year periods.



It is very interesting that in both historical Dow periods the first half of the graph, roughly
the first 17 years, witnessed generally sideways trading action. As time relentlessly
marched forward valuations gradually descended as corporate earnings caught up with
stock prices, but for the most part there were no spectacular moves in the Dow 30.

In striking contrast, roughly near the halfway point of each 33-year cycle, the DJIA
exploded upwards with great fury in both great bullish cycles. Note that both of the
Y-axes above are zeroed which helps illustrate that the raw magnitude of both the 1960s
and the 1990s bull markets in the elite Dow 30 were very similar.

Provocatively, both great bull markets launched after a long and boring 17-year basing
period in a massive sideways trading range. In addition, and this is a rock-solid
historical fact that the perma-bulls are deathly afraid of investors knowing, both great bull
markets in the second half of the 33-year cycles began marching northwards from very
undervalued broad-market P/E valuation ranges!

As we explained in “Century of the Dow”, on average over the last century the US equity
markets have traded at a P/E of 13.5 times earnings, which equates to a reasonable
return of 7.4% per year. As all the ultimate wisdom in investing can be distilled into four
simple words, Buy Low Sell High, it makes great sense to buy into the stock market
when it is undervalued (buy low) and sell when it becomes overvalued (sell high). Giant
oscillations between periods of general stock market undervaluation and general stock
market overvaluation undulate through financial history with great regularity. The time
periods compared above drive home this crucial historic strategic truth.

Just as Adam Smith realized and discussed, there are great pricing cycles that run
through history. And while history never repeats itself exactly on a micro-tactical level, it
does have stunning strategic symmetry in macro-financial terms. Smith reasoned that
when greater than normal profits could be made in an industry, meaning low P/E
valuations, investors would rush into the industry and bid up stock prices until the profits
were once again normal. Smith also reasoned that when only lower than normal profits
could be achieved, as when P/E valuations are too high, investors would pull their capital
out of an industry to seek higher profits elsewhere and stock prices would be sold down.

The enormous effects of free-market supply and demand on everything from labor to
capital to commodities was the very cornerstone of Adam Smith’s brilliant free-market
theories. Untold multitudes of citizens each acting solely in their own rational economic
self-interest would unknowingly in aggregate create titanic macro-economic market
forces that Smith called “The Invisible Hand”. As I eagerly devour Adam Smith’s
brilliance published centuries ago in 1776, I feel an incredible sense of déjà vu as his
words apply perfectly to the economy and market environment today. True wisdom is
timeless!

We created the graph above as a simple illustration of how the ridiculous Cult of the
Short-Term today blinds investors to crucial strategic market truths that could help them
earn far higher returns on their investments and suffer far fewer losses. By over-focusing
on meaningless day-to-day market noise, today’s investors are being led down a very
dangerous path and they are completely oblivious to the monumental risks lurking all
around them.

If you are an investor and all you are exposed to are worthless intra-day charts and you
are led to believe that “the long-term” is only six months, how can you thrive in an
environment where major strategic market cycles take roughly 17 years (major bull OR
bear), 33 years (major bull AND bear), and 66 years (Kondratieff Wave) to run their
courses? Obviously, the answer is you can’t! Rather than helping investors reach new
levels of sophistication and understanding, which would eventually create vast wealth,
today’s Wall Street hype industry is dooming investors to relearn the hard and painful
lessons of the recent past, at great risk of massive losses of scarce capital.

As Adam Smith understood well, and history has rightfully placed him on a very high
pedestal because of his amazing wisdom and insights, true economic analysis requires
careful, logical, and rational study of long-term data. The crushing and oppressive chains
of the Cult of the Short-Term are one of the great financial market tragedies pervading
our surreal post-bubble era.

As the Dow 30 tends to repeat itself in a macro-strategic sense over 33-year cycles,
what implications does the now widely heralded Dow trading range have for the
potential DJIA trajectory in the coming years? Is the trading range that is being widely
discussed today a blessed harbinger of a great new bull market starting later this year or
next, or is it a cursed omen foretelling much great pain and wailing and gnashing of teeth
for many years into the future?

At the apex of the great bull cycle of the 1960s, the Dow 30 challenged the at-the-time
lofty level of 1000 and general market P/Es became far overvalued at 24.1x earnings.
Rather than crash as in 1929 (which incidentally witnessed a peak broad-market P/E
much higher of 32.6), after the DJIA challenged 1000 in February 1966 it rolled over into
a brutal roughly 17-year trading range. Stock prices had ballooned so outrageously high
in the late 1960s that it took corporate earnings almost 17 years until 1982 to fully grow
into stock prices!

Historical trading ranges after major bull market runs generally take 17 years to resolve
themselves, a sobering prospect. Interestingly, after the DJIA first approached 1000 in
1966, it took roughly 17 long years until 1982 until the big round
psychologically-imposing 1000 number was left in the dust forever!

As we rapidly approach the three year anniversary of the Dow 30 first closing above
10,000 on March 29, 1999, it is ominous to behold that the Dow 30 is still not trading
much above 10,000 even three years later! Do you remember all the mega-hype when
the Dow 30 first broke through 10,000 in March 1999 predicting that it would continue to
soar to the heavens with 20%+ gains per year? If that flawed prophecy had proven true,
we would have a DJIA of 17,280 today, not 10,000!

Today, nearly three years after 10,000 first fell, are we trapped in the Curse of the Dow
Trading Range?

Our next graph is merely a hypothetical flight-of-fancy, like a pro-forma earnings release,
so please don’t read too much into it. On February 9, 1966, the Dow 30 topped at the
lofty level of 995.2 which marked the end of a great bull market. After that peak it took 17
years of brutal sideways trading before corporate earnings finally caught up with stock
prices and laid the foundation for the next great bull market which began galloping in
1982. On January 14, 2000, the Dow 30 topped again at 11,722.98 after a spectacular
roughly 17-year run from 1982.

As it is extremely difficult for investors today to really visualize just how ugly a standard
17-year DJIA consolidation trading range truly is, we decided to take a flight-of-fancy
and create a hypothetical Dow future using real past historical data. Lining up the two
daily respective bull-market tops in February 1966 and January 2000, we applied the
actual daily percentage gains and losses of the DJIA from 1966-1982 on a daily basis
starting in January 2000 and ran the series 17 years into the future.

The blue line below is actual DJIA closes since January 2000. The yellow line is the
hypothetical projected Dow 30 using daily trading data of the DJIA from 1966-1982.
White P/E ratios are actual P/E ratios for today’s broad US market, while the yellow P/E
ratios are the historical broad-market P/E ratios from the 1966-1982 timeframe.

PLEASE realize that this graph is totally useless for tactical trading! The actual peaks
and troughs in the Dow 30 in the coming years will certainly not play out to this precise
tactical timing. This fantasy-graph is ONLY useful as a general broad strategic tool to
help visualize what an honest-to-goodness 17-year consolidation trading range in the
Dow 30 would look like starting from the last great Dow top of 11,723. The results are
not pretty and should cause all buy-and-hold automaton Dow 30 investors some serious
pause.



Imagine the fun of buying the Dow 30 now at 10,000 or so, patiently waiting 14 more
years, and still having the Dow trading range-bound at 10,000 or so? To me it sounds
like the kind of horrible nightmare from which you wake up drenched in cold sweat and
are so relieved that it was only a nightmare and not reality!

The whole horrific idea of a true historical consolidation trading range after a great bull
market ought to utterly terrify all buy-and-holders. Long trading ranges are wonderful for
smart speculators who are willing to actively buy and sell specific stocks, but are
extremely dangerous for long-term buy-and-hold investors who think they can deploy
capital and then blissfully ignore it.

Our current massive Dow 30 trading range has already been running for 3 years since
March 1999, so if the expected historical 17-year consolidation trading range once
again rears its ugly head, we are potentially looking at 2016 or so before the DJIA gets
really interesting again from a bullish perspective. 2016?!?! Yes, that is a LONG ways
away!

The perma-bulls are right that today’s Dow trading range could be a basing period for a
great new bull market. The big question is when? Next year? 14 years from now? The
sideways trading range will probably continue until US corporate earnings catch up
enough with stellar Dow 30 stock prices to leave the general US equity-market P/Es
undervalued.

In 1966, the great Dow bull peaked at a general market P/E of 24.1. After trading
sideways for 17 years, the Dow 30 ultimately reached half fair value in March 1982, with
general markets trading at 7.0x earnings, which happened to herald the very birth of one
of the greatest 17-year bull market cycles in history. In 2000, the next great Dow bull
peaked at a far higher general market P/E of 44.2. It may indeed again take 17 years in
total, about 14 more years, for the earnings of the US stock market to catch-up with
astronomical stock prices and lay solid fundamental foundations for the next major Dow
30 bull market.

Note above how the yellow P/E ratios for the 1966-1982 DJIA consolidation trading
range gradually declined over time as corporate earnings increased and stock prices
remained relatively stable. It is sobering to consider that one of the best-case scenarios
from a historical and fundamental perspective for the coming Dow 30 action in the next
14 years or so is a similar excruciating sideways trading range!

Worst case, the Dow 30 could easily buck the trading range and head down much
faster. Based on the far higher peak P/E reached in this most recent DJIA speculative
mania as compared to the mighty bull of the 1960s, we believe that there is a high
probability that we could actually see the Dow 30 plunge to the 4000 range at some
point in the next few years. In many ways, a quicker washout bottom for the Dow 30
could be less psychologically damaging to investor confidence than a 17-year trading
range! Following a washout bottom, a new bull market could commence much sooner
than if we all have to suffer through a brutal 17-year sideways moving Dow 30.

The last great 17-year trading range of the Dow 30 followed a normal great bull market
that spawned mid-Kondratieff Wave and did not quite reach speculative-mania
proportions. By any measure, the most recent great bull market since 1982, however,
was a classic speculative mania. In history speculative manias tend to collapse rapidly
from broad-market P/Es over 27x earnings (double 13.5x fair value) while
non-speculative-mania bull markets tend to fade more slowly into the future from P/Es
under 27x earnings in a very long and challenging sideways trading range.

With a staggering peak market P/E of 44.2 in this latest speculative mania cycle, I
suspect that the probability of a Dow 30 swoon to 4000 or so is at least equally as likely
as the Dow excruciatingly oscillating around 10,000 until 2016. I would assign the
chances of both events at about 49% each. The perma-bull hypothesis of a magnificent
new bull roaring up from current levels, based on history and fundamentals, probably only
has a 2% chance or less of coming to pass in the next few years.

The implications of the potential Curse of the Dow Trading Range might seem
overwhelmingly negative, but they are actually quite positive.

Investors today who wish to heed history are probably best off selling the Dow 30 now at
very high valuations and investing in other arenas such as the approaching commodities
boom in the coming years until general US equity market P/Es once again trade under
fair value in a decade or so. After we weather the high potential for a 17-year trading
range, the case for the launch of a great new Dow 30 bull will once again be awesome.

The great bull market in the Dow 30 that reached maturity in the 1960s carried it from
under 100 to almost 1000, a ten-times gain. The great bull market of the Dow 30 that
came of age in the 1990s carried it from well under 1000 to almost 12,000, once again
a spectacular run of over an order of magnitude increase in DJIA stock prices. If the
33-year and 17-year DJIA cycles continue to hold sway into the future, and there is no
reason to suspect that they won’t, we could very well see the Dow run from under 10,000
in 2016 or so to over 100,000 by 2033 or so in the next great DJIA bull! Won’t that be a
heck of a ride!

Unlike those hopelessly trapped in the Cult of the Short-Term today, investors who study
and understand longer market cycles and history will have a huge advantage over all
those who don’t study markets beyond six months. Just as taking the longview a couple
of centuries ago helped Adam Smith craft wonderful free-market truths that will exist and
be celebrated forever, investors who maintain the invaluable strategic longview
perspective on the equity markets today will vastly raise their probability of achieving
enormous investment success.

Strategic perspective is everything in the financial markets as they inevitably richly
reward those who seek to understand their dearest secrets, which are only revealed
over the long-term!

The Curse of the Dow Trading Range, if it once again comes to pass in the coming
decade, is certainly not the end of the world. Prudent investors who plan for it and act
accordingly will probably reap legendary profits as they trade out of the Dow while it
languishes sideways and wait to buy back in aggressively until halfway through the next
33-year cycle in 2016 or so when the next great Dow 30 bull is due to start galloping. If
the Dow swoons dramatically, sub-fair-value levels could actually be achieved well
before 2016, giving a much earlier chance for the next immensely profitable Dow 30
buy-in.

Until then, beware of the Curse of the Dow Trading Range!

“It could take 10 years - maybe 20 years - to bring stocks back to their mean
levels. But someday, somehow... they'll get there.” - Bill Bonner, The Daily
Reckoning (www.dailyreckoning.com), March 21, 2002

Adam Hamilton, CPA

March 22, 2002

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Thoughts, comments, flames, letter-bombs? Fire away at … zelotes@zealllc.com Due to
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respond to comments personally. I WILL read all messages though, and really
appreciate your feedback!

Mr. Hamilton, a private investor and contrarian analyst, publishes Zeal Intelligence, an
in-depth monthly strategic and tactical analysis of markets, geopolitics, economics,
finance, and investing delivered from an explicitly pro-free market and laissez faire
perspective. Please visit www.ZealLLC.com for more information,
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gesamter Thread:

• Fundamentalanalyse - Dow auf 4000 und 17 Jahre seitwärts? - R.Deutsch, 23.03.2002, 11:24
  • Re: Fundamentalanalyse - Dow auf 4000 und 17 Jahre seitwärts? - black elk, 23.03.2002, 11:47
    • Re: wenn das willkürlich sein soll, dann nehmen wir mal ne 200jährige Geschichte - kingsolomon, 23.03.2002, 11:56
      • Re: wenn das willkürlich sein soll, dann nehmen wir mal ne 200jährige Geschichte - black elk, 23.03.2002, 12:05