2011 Echoes From The Past (Part 2)

Stock Indices Forecasts Based On Dividend Yields

In March 1997 I did an analysis addressing Stock Evaluation based upon Dividend Yield: www.gold-eagle.com/analysis/stocks_over-valued.html

Ten years later in March 2007 I did an updated market analysis:

www.gold-eagle.com/gold_digest_05/vronsky032207.html

On April 17, 2011 I posted 2011 Echoes From The Past (Part 1)

www.gold-eagle.com/gold_digest_08/vronsky041711.html

The above three studies addressed one of the most fundamental and basic evaluation techniques, based upon DIVIDEND YIELD of the stock index. The principal theory is that if the Average Dividend Yield is too low, it reflects an over evaluation of the stocks making up the index....ie stocks are over-bought or too high in price. Consequently, a stock market correction will cause the Average Dividend Yield to rise to acceptable levels.

A simple test of the dividend yield as a forecaster of future stock prices is presented in the table below (courtesy of "Stock Market Logic"). Shown are the one year returns which have ensued from various DJIA dividend yield intervals since 1941.

www.gold-eagle.com/analysis/stocks_over-valued.html

During the 35 year period (1941-1975) the Dividend Yield was under 3% only 17 weeks (in mid-1959 and early 1966) - and in each case the average ensuing one year market return was sharply negative....ie the stocks indices crashed, which eventually raised the Average Dividend Yield to acceptable levels.

Again in March 2007 the DOW average Dividend Yield was a mere 2.50%. As we all well know history does NOT always repeat. NONETHELESS, the then pitifully low Dividend Yield suggested Wall Street stocks might drop 10% in value during the next 12 months. However, the correction was far deeper than history might have predicted. The ensuing bear market plummeted stock by 54% during the next 17 months.

By the end of 2008 the Average Dividend Yield on the Dow was 3.9%...but rose to 4.4% by February 2009 as stocks continued to be hammered lower. To be sure it was the Fed's decision in early March 2009 that saved the day by announcing it was going to implement Quantitative Easing. This nailed the Dow's bottom at approximately 6500 with the Average Dividend Yield close to 5.0% - THE HISTORICAL AVERAGE.

Since March 2009 DOW stocks soared 89%, fuelled by QE1 and QE2 pumping liquidity into the markets. Needless to say, the rising market has again cut the Average Dividend Yield to a paltry 2.74% - far far from historical Dividend Yield of 6% when fairly priced.

DOW Performance since March 2009 is +89% -

http://stockcharts.com/h-sc/ui?s=$INDU&p=D&st=2009-03-09&en=1998-12-31&id=p50735088420

S&P500 Performance since March 2009 is +96% -

http://stockcharts.com/c-sc/sc?s=$SPX&p=D&st=2009-03-09&en=1998-12-31&i=t67098227930&r=4912

DOW's Average Dividend Yield Today has fallen to paltry 2.72% -

www.indexarb.com/dividendYieldSorteddj.html

S&P500's Average Dividend Yield Today has fallen to miserly 1.73% -

www.indexarb.com/dividendYieldSortedsp.html

NASDAQ's Average Dividend Yield Today has fallen to a absurdly low 0.79% -

www.indexarb.com/dividendYieldSortedn1.html

The above analysis forces objective investors to conclude the following:

• Stocks are grossly over-valued
• A stock market correction draws nearer every day the DOW rises
• Today's Average Dividend Yield is less the half the historical average
• The longer stocks dally to correct, the greater will be the eventual crash
• Smart investors will be looking for alternatives or just fleeing to cash

Possible Scenario Going Forward -

Were the DOW and S&P500 indices to again rise to the historical Average Dividend Yields of 5.0% and 3.0%, respectively, each index would need to fall to the following levels:

• Index............Current Div Yield.........Must Correct To Historical from close on 04/21/11
• DOW.....................2.72%............................-46% to 6800 (vs 2009 low of 6500)
• S&P500.................1.73%............................-40% to 800 (vs 2009 low of 660)

......which might occur before yearend (based upon recent volatility of the crash in late2008-early 2009).

www.globalprofitsalert.com/wp-content/uploads/2011/02/S-P-500-dividend-yield.jpg

What can the reader take away from the above analysis and historical data:

STOCKS ARE SIMPLY TOO DEAR..... and so expect a BIG correction!

--

I. M. Vronsky

Editor & Partner - Gold-Eagle

www.gold-eagle.com