Good Luck on Friday the Thirteenth

by | Dec 13, 2002 | Archives

Recent messages have looked at why stock markets are recovering and when we should beware of yet another crash. There is evidence that the market is starting to overheat so Friday the thirteenth is a good time to remember danger and I want to share an important warning here with you.

USA Today's December 4 article “Investors suppress tech memories” shows the risk clearly enough. Some stocks are overheated. “P-Es of some stocks are soaring.”

As of December 4 the USA Today Internet 50 Index was at a sky-high P-E ration of 70. This is just plain crazy. Ebay is selling at 104 times earnings and Intuit's P-E at 86 is higher than at the peak of the market in 2000.

Why would anyone want to invest in something that is so expensive?

Look at these overheated P-E ratios shown in this article:

Yahoo 217, WebEx 107, Ebay 104, Expedia 95, Network Appliance 95, Charles Schwab 94, Intuit 86, 74,Siebel Systems 73 and Network Associates 71.

Even Merrill Lynch chief strategist Richard Bernstein, (according to another article in the Money section of the same 4 issue) has stated that this run-up shows too much speculation. He has shifted his recommended weightings away from shares to bonds. He cut his equity weighting recommendation from 50% to 45% and raised bonds from 30% to 35%.

One of my investment bankers on the Isle of Man agrees when he just sent me this message.

"Gary, I believe we have seen the end of a multi-year bull market and that the best we can hope for is range trading for some years whilst the market moves towards its historic mean from its present over stretched valuation. This would be broadly similar to what happened at the end of the other two major bull markets of the 20th century. Of course the markets tend to overshoot in both directions, so we will quite probably see extreme value before the next major bull run begins. I do not expect inflation adjusted returns from the equity markets to be inspiring.At present the pattern of the end of the bull run and subsequent pull back are almost a carbon copy of what happened with the Japanese market 10 years earlier. Try overlaying the charts, it's scary. Of course the Fed. will not make the mistakes made by the Bank of Japan, they will pump liquidity into the market until any threat of deflation has been wrung out of the system. The government will not make the mistake of wasting vast amounts of public funds keeping unprofitable companies afloat. The market in the U.S. knows how to deal with non-performing loans. The country most likely to follow Japan into the economic version of a nuclear winter is Germany, as they cling to an outdated economic model, has inflexible labour laws and bankruptcy is regarded as a national disgrace. Germany has the added disadvantage of having lost control of monetary policy and having no fiscal room to maneuver.We have a situation where the risk / reward ratio in stock markets does not encourage investment there. Bond yields are very low but will rise in the not too distant future as the expansion in the money supply and increased government borrowing cause investors to demand higher interest returns from bonds. In this scenario capital protection should be the main criteria in investment decisions. In this regard we should look towards good quality floating rate notes and the presently out of favor index linked bonds. I would also look at gold. This has been out of favor for a great many years as inflation has been tamed and other asset classes have performed well. Looking ahead inflation will pick up.Bond holders will see capital diminution as interest rates rise. This will increase the lack of faith in the investment markets, and with inflation eroding the real value of cash, the old store of wealth will probably come into its own again. The chart is very interesting showing that gold is very close to completing a multi-year base. When this happens the next move could be quite explosive and we could ultimately see the old high from 1980 being challenged.Sorry to be so gloomy at this time of year, but we have to be realistic."

We can see from the above that many agree. Investing in high priced shares violates all the laws of investing in value. ( Jumping into too many high tech shares distorts asset allocation principles. (( Such investing also often violates most of the rules of piec investing as well. ((

Please look again at the charts and message at ( These show that Wall Street is almost certainly in the midst of an extended downturn that could last another decade. This run-up is the first of several mini booms we can expect in an extended period of sideways motion.

This is a time to be thinking of taking profits rather than increasing portfolio of overvalued shares. Be very careful that you are not caught on the first sudden downturn we are almost certain to see. And most of all on Friday the thirteenth and every day you invest, be careful. There are a lot of crooks, thieves and scoundrels out there. And until next message, good investing!