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Dr. Paul Price
Dr. Paul Price
Articles  | Author's Website |

Partying Like It's 1999?

Are stocks too risky to hold or should investors hang in there?

August 14, 2016 | About:

Partying like it's 1999? Not really.

Thursday, Aug. 11, saw all three major indices close at new record highs. That hadn’t happened since Dec. 31, 1999, just a few months before the painful end of the tech and internet mania.

The broad market, led by the NASDAQ, surged ahead for a few more months before beginning an epic retreat. The World Trade Center attacks of 2001 led to a few days’ trading halt followed by a short-term bottom. Patriotic sentiment then ignited a solid recovery through early in 2002. That preceded one of the most grinding and painful six-month periods in modern times.

The final floor was put in during the first week of October 2002, laying the foundation for a multi-year run which lasted well into 2007.

Were last week’s new highs a warning to get out before a repeat of the 2000 to 2002 collapse?

Let’s go to the data before deciding. The DJIA and Standard & Poor's 500 blue-chip indices have had decent moves recently. As of Aug. 12, the DJIA was up 6.61% year-to-date but only 6.29% over the trailing 12 months. The S&P 500 was a shade better this year at 6.85%, but was up only 4.85% for the 52 weeks.

Unlike 1999, the tech-heavy NASDAQ Composite has been the weakest market segment, both year-to-date and over a full year. The Fed’s ZIRP (zero interest rate policy) may have contributed to that as pension funds and individudals sought out more conservative, dividend-paying stocks rather than high-flying tech names with small or non-existent cash payouts.

Comparing the Nasdaq COMP’s last 150 trading days to the same time frame leading up to Dec. 31, 1999, really illustrates the shocking tale. During tech market mania the NASDAQ surged by 66% versus just 4.4% in the 150 sessions through last Thursday.

Most stocks are not cheap in historical context, but today’s situation is far from the insane valuations back in late 1999 and early 2000.

ZIRP has changed everything. Bonds and bank CDs used to compete for investors’ capital while offering decent, risk-free income. In 1999 and 2000 you could avoid equity risk while locking in FDIC-insured better than 7% yields.

Traders were paying outrageous multiples despite decent yields. That was the definition of insanity.

Risk-free rates of around 7% should have kept a lid on P/E multiples. In 1999, no-growth companies were only “worth” as much as 14.3x current earnings on an owner equivalent basis, before adjusting downward a bit for an equity risk premium. These days, competing against sub-1% CD rates has turned much higher price to earnings multiples into acceptable-range alternative investment possibilities.

Bankrate.com reported the national average bank money market fund now pays a paltry 0.11% annual percentage yield. That already unattractive number is both pre-tax and pre-inflation. The real rate of return becomes decidedly negative.

Risk-free returns have morphed into return-free risk.

The best you can say right now is that America has, so far, resisted the urge to experiment with NIRP (negative interest rate policy). With our national debt fast approaching $20 trillion, the gravitational pull of that idea may be too tempting for Washington D.C. to resist.

The idea of owning stocks at historically high valuations is less unappealing than the thought of locking in long-term money in fixed income or money market accounts, which offer a virtual guarantee of losing purchasing power over time.

Deciding on investments right now is very much like the choices presented to us in the upcoming presidential race.

Pick your poison.

Disclosure: I remain heavily invested in stocks. I own no bonds or CDs.

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About the author:

Dr. Paul Price
http://www.RealMoneyPro.com

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Rating: 5.0/5 (8 votes)

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Comments

Earl.Nancy
Earl.Nancy premium member - 3 years ago

Dr Price,

With a difficulty rating of 16.30, I judge this article as a 16.21. You win the Gold!

A Million Thanks,

Nancy Davis

rherion7
Rherion7 - 3 years ago    Report SPAM

Very good article! I agree, if you are looking for long term future expected returns, stocks are the place to be compared to fixed income. Earnings yield of the S&P 500 approximately 4%, vs. yield on high quality corporate bonds of 3%, 30 year treasuries at 2.2%, 10 year treasuries at 1.6%. IMO, the shoe has been put on the other foot and fixed income is now the most risky asset class. I would be very scared to own a portfolio of bonds with a duration of 10 years or longer. Matter of fact, if you deem it necessary to include bonds in your portfolio, my recommendation would be to allocate that portion to cash. It is not worth the risk to earn a 1.5% to 3% annually, and risk the economy heating up and interest rates starting to rise rapidly and lose 10-30% on longer term bonds. Over the last 30 years the 10 yr T average yield has been approximately the same as the average earnings yield of the S&P 500 during that same period, if that were to hold for today the P/E ratio of the S&P 500 would be about 66.

If someone tells you stocks are overvalued, ask, compared to what? Stocks are on the high side of fairly valued when compared to history, however we have never seen interest rates this low. IMO bonds are in a bubble comparable to the 2000 dot com bubble. W

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