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Bubbles, Bears, and a Case for Gold
02/11/2015 10:00 am EST
Market history, sentiment, margin debt, and derivatives are among the reasons for investors to take a cautious stance, according to Alan Newman. Here, the editor of CrossCurrents, outlines his negative case for stocks and his concurrent bullish long-term stance on gold.
Steven Halpern: Our guest today is Alan Newman, editor of CrossCurrents. How are you doing today, Alan?
Alan Newman: I'm great, Steve. Thanks for inviting me on.
Steven Halpern: Well, thank you for joining us. I'm always fascinated by your research because instead of looking at market noise, you take a truly big picture approach to the market. From your long-term view, could you tell our listeners a little about your outlook for the stock market?
Alan Newman: Unfortunately, it's not good. We survived a veritable mania from 1998 to 2000, but not before stocks were cut in half from 2000 to 2002. We survived another mania including one in housing in 2006 and 2007 but, again, stocks were cut in half from 2008 to 2009. I might add that we barely survived that particular fallout.
We came extremely close to a financial collapse. While valuations were somewhat high in 2000 as NASDAQ and tech went absolutely bonkers, valuations today are nonetheless off the charts.
Tobin's Q Ratio, which basically just measures the replacement cost of corporations, is at its second highest in history. Shiller's cyclically adjusted price-to-earnings ratio is at its third highest in history. The stock market is extremely overvalued and these prices cannot be sustained since they discount a perfect scenario for perhaps five to ten years down the road.
In other words, if the next ten years are not dead on perfect, you're probably paying way too much for stocks today. Also, sentiment is off the charts. There are no bears left if you look at advisory sentiment.
Typically, bears average roughly 26.5% over history. Since the beginning of 2014-that's over a year ago-they have averaged only 16.5%. Anything under 20% is considered indicative of an environment that is dangerous, simply because too few advisors see any real downside.
Also, margin debt is at all time highs and with all that borrowed money in stocks, you have the stage set for a momentous decline once the decline begins to accelerate.
Maybe we're okay if we just see modest corrections, but if prices take out the October, 2014, lows-some 11% below-we're likely to see a mass exodus and a much worse decline develop as well.
Steven Halpern: In your latest issue, you point to the market's capitalization adjusted for inflation and, surprisingly, conclude that the bull market hasn't really gained much in value over these years. Could you explain that?
Alan Newman: Sure. Inflation is a fact of life. Our population grows and there is more demand for everything, so prices rise. Consumer price index has risen roughly 23% to 24% in the last ten years, 57% in the last 20 years; stocks need similar gains to keep pace.
Well, they've more than kept pace over the last 20 years, but that includes two veritable manias and three if you count today's stock market, which I believe is the third mania, albeit confined primarily to institutions rather than the public.
Over the last ten years, stocks have not kept pace. The total value of stocks is now below where it was ten years ago. It's close, but total stock wealth has yet to make a new record high.
Steven Halpern: Now, in past downturns, there's been a lot of talk in the media about derivatives and it seems that's faded as the market has recovered in the past few years, but you continue to view this as a very troubling factor. Could you explain that?
Alan Newman: Sure. The crash in 1987 was actually a derivative event based on stock futures, which are derivatives. We came close to a total financial collapse on Tuesday, October 20, 1987, when we briefly traded below Monday's crash low. We had another derivative event in 1998 when long-term capital management collapsed.
We had another in 2008 with fast turns and Lehman Brothers and the stage is set again simply because notional values of derivatives have expanded so sharply. Notional values now equate to 10 times the entire capitalization of the stock market and are roughly 14 times gross domestic product.
An event that impacts only 2% of the total can bankrupt most or all of our largest banks. They were too big to fail in 2000 and they are still too big to fail. In a worst case scenario, they will all be bailed out again at a cost to the tax payers…us.
Simply put, all the good bets they make pay off, but so do their bad bets. We are underwriting any bad bets they make going forward, which insure bad bets. This is a very troubling scenario.
Steven Halpern: Now, within this environment, your number one sector for investors is gold. Could you share your thoughts on the gold market and perhaps touch on a couple of names in the group that you might suggest for investors who are interested in the long-term gold position?
Alan Newman: Sure. Gold has been my number one choice since the terror event in 9/11, which I believe offered us proof that the world had forever changed.
It coincided close enough to the fallout of the tech mania to substantiate the notion that the fiat world of paper money and paper assets had also reached a plateau that could last a generation from there. We're only halfway into that.
I have been a big champion of Newmont Mining, that's symbol (NEM) on the New York Stock Exchange. Goldcorp, that's (GG) also on the New York Stock Exchange and I have one speculative favorite, but I will reiterate this is a speculative play. It's called IAMGOLD and the symbol is (IAG).
I do think gold is likely headed to $3000 an ounce or higher-eventually-I don't know what eventually means. That could be a year from now; it could be five years from now. I think the age of paper money and paper assets has come to a close, or is coming to a close, and a hard asset like gold is going to shine for years to come.
Steven Halpern: Well, it's fascinating to hear your insights and we really appreciate you taking the time today. Again, our guest is Alan Newman, editor of CrossCurrents. Thank you so much.
Alan Newman: My pleasure.
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