Still On The Threshold Of A Major Bear Market

Let’s look at Mr Bear’s report card to see what he’s been was up to this past week.  After one day of extreme volatility on Monday, he’s been behaving himself.  Still the Dow Jones ended the week 10% below its last all-time high of May 2015.

Next graphic is the Dow Jones’ step sum chart, where we see quite a difference in the current decline compared to the beginning of the credit-crisis bear market.  From October 2007 through October 2008 the Dow’s step sum’s trend refused to decline with its price until the Dow Jones itself had already dropped 40% from its last all-time high of a year earlier.  A bear box such as this is the hallmark of stubborn bullishness in the face of disaster. 

Bear boxes form because at first each market decline seems like a buying opportunity to the bulls.  The step sum refuses to go down because the day following any market decline, large or small, the bulls are back scooping up stocks at what seems to be bargain prices.   This results in the market going up the next day, canceling out the previous day’s step sum decline.  But within a bear box, price gains from advancing days seldom cancel out the losses suffered during the declining days, as the bulls were to discover from October 2007 to October 2008.  After a year of declining prices, in October 2008 the Dow Jones finally crashed 40% below its all-time high.  Only then did the bear box closed as the step sum collapsed (dashed black line), indicating the bulls finally realized that in a bear market Mr Bear always wins.

In our current market decline, (which I suspect is the beginning of a massive bear market that will take the Dow Jones down 70% or more before it’s over), the bulls have so far been wary of scooping up bargains as the market declined.

Next we see the Bear’s Eye View (BEV) for the Dow Jones from the absolute bottom of the credit crisis bear market.  BEV charts compress market history within a percentage range of only 100 percentage points:

• 0.00%: (aka BEV Zero) = new high for the move OR new all-time high.
• -100%: Total wipeouts of market valuations.

In the chart below we don’t have a sense of the success the “policy makers” had re-inflating the market from its credit-crisis lows of March 2009.  In a BEV plot every new high of the move or all-time high is registered as a 0.00%.  Whether the new BEV Zero is two cents or two hundred dollars above the previous BEV Zero it’s all the same to Mr Bear – a big fat zero.

The amazing thing the chart above misses is that from the Dow Jones’ March 9, 2009 bottom (6,547) to its last all-time high of May 19^th, 2015 (18,312) the Dow Jones advanced 11,765 points.  At the very top of Greenspan’s high-tech bubble in January of 2000 the Dow Jones peaked at 11,722 following an eighteen year bull market.  So, incredibly just the six year gain in the Dow Jones since 2009 actually exceeded the entire cumulative value of the Dow at its peak before the crash of the high tech bubble.  The Dow Jones’s amazing gains since March 2009 only happened because the know-it-all academics sitting at the FOMC decided to inflate market valuations with massive “injections of liquidity.”

Does that bother you?  It should!  There’s going to be deflationary hell to pay before this bear market is over.  The Dow Jones ended the week only 10.26% below its Terminal Zero (TZ: last all-time high of a bull market).  The best way to capitalize on our current high-market prices is to exit the market while you still can, and don’t be in any hurry to get back in. 

Are there some market yardsticks we can use to gauge when it’s safe to re-enter the market?  I believe there is: when the Dow Jones dividend yield rises significantly above 6%.  And as the “policy makers” have manipulated the entire yield curve far below where the free market would have had them – for years, I’m also be paying attention to the yield on the Treasury’s long bond.  When the Treasury’s long bond yield exceeds its October 1981 all-time high of 15%, we can take that as a bullish indication that most of the inflation currently in market valuation has deflated.  But these two market conditions won’t happen until the climatic end of our bear market, which may be years from now.  Warning: if you tell anyone about my two market yardsticks they’ll think you’re crazy.  But then most people accept current market valuations and the past seven years of zero interest rate policy as normal.

In any bear market dividends become increasingly important, though not immediately.  Barron’s began publishing Dow Jones dividend payouts and yields back in October 1925.  The chart below shows the ninety year history of Dow Jones dividend payouts.   

It quickly becomes evident why dividend income, unlike bond income, is not classified as “fixed income.” Bonds are contracts for debt.  Investors buy a 20 year bond for say $1,000 with a 5% coupon, and for the next twenty years the company pays out $50 a year to the bond holder and then returns the $1,000 after the twenty years.  But investing in bonds only makes sense if the currency in which the bond issuer services its debts is based on gold or silver.

Our “modern” monetary system is based on an ever increasing volume of fiat money in circulation, a system designed to benefit the few at the cost of the many.

"The few who can understand the system (An American Central Bank) will either be so interested in its profits, or so dependent on its favors, that there will be no opposition from that class, while on the other hand, the great body of the people, mentally incapable of comprehending the tremendous advantages that capital derives from the system, will bear its burdens without complaint and perhaps without even suspecting that the system is inimical to their interests."

- John Sherman, protégé of the Rothschild banking family, in a letter sent in 1863 to New York Bankers, Morton, and Gould, in support of the then proposed National Banking Act.

“the great body of the people, mentally incapable of comprehending the tremendous advantages that capital derives from the system, will bear its burdens without complaint and perhaps without even suspecting that the system is inimical to their interests.” 

John Sherman hit the nail on the head.  And the beauty of central bank control over the volume of currency and credit is that Karl Marx considered this crucial in his 1849 Communist Manifesto.  So, even left-leaning academics and Obama supporters bear the Federal Reserve’s burden without complaint. 

Today, there are few who advocate using gold as money.  However that will change in the not too distant future.  Look at the table in the chart below.  Currency in Circulation (CinC), freed from the discipline of the gold standard has increased from $3.96 billion in 1925 to $1,379 billion today, an increase of 34,800% over the past ninety years.  The Dow Jones dividend payout during the same period increased by only 6,700%, far less than the rate of inflation.  The difference benefitted only the patrons of the Federal Reserve: Washington’s politicians and Wall Street’s bankers.  However dividends still provided investors some compensation for inflation.  Bonds with their fixed income did not, or ever will.

But dividends are a double-edged sword.  From 1925 through 1930 Dow Jones dividends increased by 111%.  This was followed by a 77.5% payout cut over the next four years as the Dow Jones declined 89%.  What happened was not difficult to understand; the inflationary boom of the 1920s had become the deflationary bust of the early 1930s.  Thanks to Greenspan’s “monetary policy” implemented since August 1987 I expect our current inflationary boom will be followed by a deflationary bust of even greater magnitude than the early 1930s.

From 1925 up until Alan Greenspan took over the Federal Reserve the Dow Jones dividend yield could actually be used to time profitable entry and exit points in the stock market.   Note how during the Greenspan era stock valuations were never allowed to decline sufficiently for the Dow Jones to reach a 6% yield (chart below).   Greenspan was keenly aware of this data.  He must have been.  As noted in the chart’s top-right text box, he gave his historic speech on “irrational exuberance” just one month before the Dow’s dividend yield fell below 2% for the first time in history.  During the Tech-Wreck bear market Greenspan apologized for economists’ lack of foresight, claiming that no one could identify a bubble being blown in the market.  The timing of his irrational exuberance speech suggests that he wasn’t telling the truth.

The impact rising dividend yields have on market valuations is seen clearly in the chart above.  At the credit crisis bear market bottom the Dow Jones declined to 6,547, 54% below its October 2007 high of 14,164.  By March 2009 the Dow Jones was yielding only 4.74% with its payout of $310.43.  Had the Dow Jones reached a 6% yield, (the pre Greenspan era buy signal), the resulting 63.5% decline would have taken the Dow Jones down to 5,173.  But this assumes the Dow Jones could have maintained its payout of $310.43, a problematical assumption during a big bear market.

The Dow Jones’ current dividend payout is $431.35, yielding 2.62% at its current level of 16,433.09.  The table below illustrates the damage to market valuations rising yields and declining payouts will cause as the bear market progresses.

I highlighted the Dow Jones valuation with a 6% yield and a payout of $250, a reduction of $180 from its current $430; fixing the Dow Jones valuation at 4,167.  That represents a 77% decline from the Dow Jones’ last all-time high of 18,312.  If you reexamine the charts for dividend yields and payout above you’ll see a 77% Dow bear market bottom does not represent an extreme case.  Rather I’m pointing out how extremely overvalued the stock market has become since 1987 when Greenspan became chairman of the Federal Reserve.  The Dow Jones hasn’t managed to yield more than 6% since 1982!

Let’s take a look at Dow Jones earnings; like the Dow’s dividend payouts its earnings have lagged far behind CinC inflation.  Since 1982, every time the Dow Jones manages to generate $1 in earnings per $1 billion dollars in CinC (when the Blue Plot touches the Red Plot), earnings have crashed resulting in progressively deeper market declines.  The credit-crisis crash in the Dow’s earnings was stunning.  Its rebound over the past six years has been simply unbelievable. 

The accounting games the “policy makers” play today, along with corporate management’s share buyback programs are mostly responsible for the fantastic growth in earnings seen below.  Sol Palha provides excellent commentary on this exact subject, and much more in his “Forever QE Continues Unabated.”

https://www.gold-eagle.com/article/forever-qe-continues-unabated

Be that as it may, since April 2014 Dow Jones earnings have stalled while CinC inflation continues to soar unabated to ever greater heights.  This decoupling of Dow Jones’ earnings from CinC inflation is an ominous sign since earnings growth is what supports stock market valuations; or so we are told by “market experts.”   

Barron’s has been publishing Dow Jones dividend data since 1925, but didn’t begin to publish earnings data for the Dow until the late 1930s.  The earnings data seen above from 1929 to 1939 is from a stacked bar chart Barron’s published only twice showing quarterly earnings on yearly bars.  There was a good reason for this lack of interest in earnings, as is evident below.  Before Greenspan became Fed Chairman, and CNBC began their quarterly “Earnings Central” in the 1990s, timing market entry and exit points via earnings was a costly exercise in futility.

Just as during the Oct-Nov 1929 crash, the Dow Jones from January 1973 to December 1974 saw a 40% bear market (its first since 1942) on rising earnings.  The great 1982-2000 bull market began during a 90% collapse in Dow Jones earnings, just as they collapsed during its greatest year in history (the 164% gain from July 1932-33).  In the past I’ve published charts documenting the history of the Dow Jones with its earnings from 1929 to today.  The point that market history makes is that cause and effect have been reversed in the stock market since Alan Greenspan began making “monetary policy.”

Today “experts” would have us believe that trends in earnings precede trends in market valuation.  Before the 1990s, however, market data shows that price trends usually led corporate earnings.  Look at the chart above.  From 1968 to 1984 when did the Dow Jones valuation ever trend upward along with rising earnings?  Not very often.  More often than not the Dow rose on declining earnings, and when down on rising earnings, as was frequently the case from 1929 through the early 1990s.

This should make us realize how aggressively rigged market valuations have been for the past few decades.  When the rig eventually comes undone the damage to investors’ net worth can be estimated using the Dow Jones dividend payout and yield table above.

Stock market investors typically pay little attention to the bond market.  That’s a mistake as the same corporations whose stock they buy also issue bonds.  The bond market has a story to tell us too.  My favorite bond market indicator is Barron’s Confidence Index (CI).  The CI is a horrible tool for timing profitable trends in the bond market.  Instead we should think of the CI as an economic indicator: the bond market’s best guess of the likelihood companies issuing intermediate-grade corporate bonds will service these debts to maturity.

This can be a key piece of information for stock holders.  When General Motors failed to pay a coupon to their bond holders during the credit crisis, the share price lost more than 90% as the company went into bankruptcy.  Since the high-tech bubble went bust in 2000, the Confidence Index shows us that concerns over corporate solvency have been growing in the bond market. 

And this fear of corporate insolvency is completely justified.  American corporations, just like consumers, college students and government have taken full advantage of the ample “liquidity” and “attractive rates” the FOMC has been “injecting” into the banking system.  Sooner or later when the economy slows down, bond issuers’ ability to service their debts will be tested.  Just like General Motors in 2009, we’ll be seeing some well-known corporations fail to pass Mr Bear’s corporate stress test.  I expect we’ll see the Confidence Index breaking below 45 before it rises above 90 again.

NYSE margin debt appears to have peaked in April 2015.  If so that’s not a good sign, as investors discovered in March 2000 and again in July 2007.

One last chart points out the questionable accounting practiced today: three times during the Obama administration the published figures for the national debt trended sideways for months as the national debt approached the debt limit.

But as we see below, this time it’s different as the US Treasury’s reported float has already exceeded the statutory debt limit, and has for the past six months.

In the past this exact same situation would have resulted in market commentary in the financial media as well as contentious-political dialogue widely covered by network news.  Remarkably, today no “responsible market expert” cares to say a thing about the US Treasury being over extended in the debt market.  Politicians running for the presidency have chosen to ignore this issue too.  I have to consider the possibility that the 18,151 billion dollar figure for the national debt published weekly for months now has become another a completely bogus number published by the US government.

Currently the “policy makers” must be painfully aware that they are treading on dangerous ground when it comes to matters of the economy and the markets.  The media, being “team players”, aren’t looking for any market news that could rock the boat.  They are content to focus on next week’s FOMC meeting when the “policy makers” will decide whether to increase the Fed Funds rate or keep it pegged near zero.

There are many other growing problems that aren’t currently demanding the attention of the public and government.  But one day Mr Bear will demand that the “policy makers” and the public address them.  I guess what I’m trying to say is that if you’re looking for an optimistic opinion from me on the market, you may have a long wait.  A lot of pending bad news and human suffering has to pass into history before I’ll find anything bullish to write about unless I’m addressing investing in gold, silver and the companies that mine them.

Mark J. Lundeen

[email protected]