2011 Dividend tax increase cuts real value of S&P500 by 30%.

The S&P 500 is currently yielding about $25.50 per share annually, about 2.3% at today’s level. Sub-3% yields are a characteristic of the bubble years. Before the 1990s an index yield under 3% was very skimpy, hardly justifying the risk of capital loss. Reduced marginal taxation of 15% (with 0% and 5% rates for low-earners) on qualified dividends (meaning on shares held more than 1 year) helped somewhat to justify lower yields, though in the rapid-turnover casino environment after 1995 dividends have hardly mattered to a stock’s performance.

Presuming that the aftermath of the credit bubble has brought a secular value restoration phase (Jim Grant’s term) and growth is missing or anemic, dividends should take greater precedence in investors’ minds. The aging of the developed world should also play a role as retirees opt for safety and income. In this environment, the denominator in the yield equation, share prices, would be expected to adjust downward regardless of any change in tax policy.

To make matters worse, when dividends are subjected again in 2011 to 39.6% federal taxation, prices would have to fall by roughly 30% to offer the same yield, assuming constant dividends. The S&P’s $25.50 yield nets $21.67 this year for a real yield of 2.0%, but to get the same net yield next year either the payout would have to increase to a record $36 or the index would have to fall to 780 (the after-tax net on $25.50 is $15.40 at 39.6%). Although forgotten lately, the stock market’s fundamental value is derived from expected income, so taxation cuts right to the bottom of any valuation estimate.

Dividend payouts remain at the same depressed levels of late 2008 and early 2009, even as earnings have regained lost ground. If and when sales take another turn downward, perhaps aided by cuts in state and local government wages and further layoffs by small businesses, margins and dividends may again come under pressure. With the 10-year treasury bond yielding over 3.25%, where’s the margin of safety in stocks? The 5-year note even yields as about much as stocks, and unlike stock dividends, treasury yields aren’t subject to state-level taxation in the US.

As of today, there are actually some remarkably good yields available from blue-chip stocks such as utilities, consumer staples and tobacco companies. Here’s a list, updated frequently. I’d keep an eye on a few of these. If stocks fall to a level where the after-tax yield looks attractive, I’d be interested in picking up a basket of these for the long-haul. At that point in the cycle the ones with low debt will be among the safest financial instruments you could ever find, since there are productive assets backing that equity — even better if you spread out the political risk across the world.


Editorial here: Why raise these taxes (or have them at all), when the revenue derived from them is a tiny portion of the federal ledger and their imposition in all liklihood costs the government (let alone the well-being of the nation) multiples more than they generate, due to lost investment. The government blows the money — it goes down the welfare/warfare rat hole, subsidizing the worst elements at home and abroad.

So why do it? Because the people who make such decisions are either ignorant and idealogically driven (a few, such as Ivy-indoctrinated DC functionaries and academics) or just don’t give a damn about the welfare of the country (the majority). They believe that punitive taxation helps them keep office (it just sounds good to tax the “rich”), and as the balance of the western workforce shifts more and more from production to leaching as government and society age, this is ever more the case.

Not much between here and Dow 8500

Many of the world’s stock markets have already retraced large portions of the entire rally from the 2009 lows, but US equities have a long way to go before they give traders a scare. Judging from the sanguine attitudes expressed by various managers on Bloomberg TV, the majority remains firmly convinced that the lows are in and that any sell-off is just a healthy correction on the way to new all-time highs. This is exactly the same attitude expressed from late 2007 to mid-2008 before the crash got underway in force.


Since we are still in the early phase of the credit deflation and most people remain unconvinced of its magnitude and implications, this next decline in asset prices could be very swift and deep, driven by the panic of recognition. Technical support has already been taken out, and dip buyers will be less eager, since they have seen that stocks can indeed crash. We could see an unrelenting slide like the two years from April 1930 to July 1932.

There won’t be another bounce of the magnitude we’ve just seen until real value is restored by attractive dividend yields. A 7% yield on today’s dividends would put the S&P 500 at 350 or the Dow under 4000, but this assumes dividends won’t be cut and that the recent years of extreme overvaluation won’t be matched by an era of extremely low valuations as the culture of financial speculation dies off.

Take this week’s equity drop seriously.

Longs are playing with fire here. This market is at least as dangerous as 2007 or 2000. What happens when this multi-decadal asset mania fizzles out, like they all do? The last 12 months show that it won’t give up the ghost without a fight, but it is very long in the tooth, as is this huge rally. Also, the short-term action of smooth rallies followed by sudden drops is uncannily similar to 2007.

Stocks left the atmosphere in 1995, but since 2000 gravity has been re-asserting itself. After extreme overvaluation comes extreme undervaluation. On today’s earnings and dividends, even average or “fair” multiples would put the Dow near 4000, right back to 1995.


Charts from Stockcharts.com

A note on gold and the dollar:

I suspected a few weeks ago that gold had a rally coming, and now that we’ve seen it I’d be careful to use stops and not get too confident.

I still like gold for preservation of purchasing power through this secular bear market in real estate and stocks, but when financial markets turn down again in earnest it won’t be spared. Remember, it kept going to new highs in late 2007 and early 2008 after stocks had peaked, but then tanked with everything else when panic hit. Cash is still king, especially in US dollars and Treasury bonds. We may have only seen the start of this deflation.

Analysts and institutions: stocks “extremely cheap” despite 1.7% yields after 80% rally. Hussman & Prechter: another crash likely.

Bloomberg today gives a tour of the bull camp, which believes in a V-shaped recovery and soon-to-be record S&P earnings:

Even after the biggest rally since the 1930s, U.S. stocks remain the cheapest in two decades as the economy improves…

…Income is beating analysts’ estimates by 22 percent in the first quarter, making investors even more bullish that the rally will continue after the index climbed 80 percent since March 2009. While bears say the economy’s recovery is too weak for earnings to keep up the momentum, Fisher Investments and BlackRock Inc. are snapping up companies whose results are most tied to economic expansion.

“The stock market is incredibly inexpensive,” said Kevin Rendino, who manages $11 billion in Plainsboro, New Jersey, for BlackRock, the world’s largest asset manager. “I don’t know how the bears can argue against how well corporations are doing.”

S&P 500 companies may earn $85.96 a share in the next year, according to data from equity analysts compiled by Bloomberg. That compares with the index’s record combined profits of $89.93 a share from the prior 12 months in September 2007, when the S&P 500 was 19 percent higher than today.

Those figures would be for operating earnings, not the bottom line. In recent years it has been increasingly common to simply call operating earnings “earnings” and to imply that multiples on this figure should be compared to historic multiples on the bottom line. Ken Fisher, readers may recall, was running obnoxious video web ads through 2007-2008 touting a continued rally just before stocks fell off a cliff. His equity management firm makes the most money if people are all-in, all the time, as it collects fees as a percent of assets.

Record Pace

The earnings upgrades come as income beats Wall Street estimates at the fastest rate ever for the third time in four quarters. More than 80 percent of the 173 companies in the S&P 500 that reported results have topped estimates, compared with 79.5 percent in the third quarter and 72.3 percent in the three- month period before that, Bloomberg data show.

It is impressive how companies have protected themselves since the downturn began, but the way they have done this is by simply cutting costs, hence the stubborn 9.5% (headline U-3) or 17% (U-6) unemployment rate.

David Rosenberg, as usual, is the cooler head in the room:

Alternate Valuation

David Rosenberg, chief economist of Gluskin Sheff & Associates Inc., says U.S. stocks are poised for losses because they’ve become too expensive. The S&P 500 is valued at 22.1 times annual earnings from the past 10 years, according to inflation-adjusted data since 1871 tracked by Yale University Professor Robert Shiller.

Economic growth will slow and stocks retreat as governments around the world reduce spending after supporting their economies through the worst recession since the 1930s, said Komal Sri-Kumar, who helps manage more than $100 billion as chief global strategist at TCW Group Inc. The U.S. budget shortfall may reach $1.6 trillion in the fiscal year ending Sept. 30, according to figures from the Washington-based Treasury Department.

“The correction is going to come,” Sri-Kumar said in an interview with Bloomberg Television in New York on April 21. “You now have a debt bubble growing in the sovereign side, and we’re slow to recognize how negative that could be.”

We are still in the thick of the largest credit bubble in history. Consumer and real estate debt has yet to be fully liquidated (and hasn’t even started in China), corporate indebtedness is the highest ever, and now government debt has reached the point of no return where default is inevitable.

Equity is the slice of the pie left over after all debts are serviced, so to say that it is cheap when it only yields 1.7% (in the case of S&P dividends) is insane. It is much safer to be a creditor of a business than an owner, so debt yields should be lower than equity yields. In today’s perverse investment climate, even 10-year treasuries of the US and Germany yield more than twice equities.

This extreme confidence in stocks and dismissal of risk considerations further indicates that this is a toppy environment, highly reminiscent of 2007.

John Hussman explores this theme a bit further in his latest market comment:

As of last week, our most comprehensive measure of market valuation reached a price-to-normalized earnings multiple of 19.1, exceeding the peaks of August 1987 (18.6) and December 1973 (18.3). Outside of the valuations achieved during the late 1990′s bubble and the approach to the 2007 market peak, the only other historical observation exceeding the current level of valuation was the extreme of 20.1 reached just prior to the 1929 crash. The corollary to this level of rich valuation is that our projection for 10-year total returns for the S&P 500 is now just 5.3% annually.

While a number of simple measures of valuation have also been useful over the years, even metrics such as price-to-peak earnings have been skewed by the unusual profit margins we observed at the 2007 peak, which were about 50% above the historical norm – reflecting the combination of booming and highly leveraged financial sector profits as well as wide margins in cyclical and commodity-oriented industries. Accordingly, using price-to-peak requires the additional assumption that the profit margins observed in 2007 will be sustained indefinitely. Our more comprehensive measures do not require such assumptions, and reflect both direct estimates of normalized earnings, and compound estimates derived from revenues, profit margins, book values, and return-on-equity.

That said, valuations have never been useful as an indicator of near-term market fluctuations – a shortcoming that has been amplified since the late 1990′s. The lesson that valuations are important to long-term investment outcomes is underscored by the fact that the S&P 500 has lagged Treasury bills over the past 13 years, including dividends. Yet the fact that these 13 years have included three successive approaches (2000, 2007, and today) to valuation peaks – at the very extremes of historical experience – is evidence that investors don’t appreciate the link between valuation and subsequent returns. So they will predictably experience steep losses and mediocre returns yet again. Ironically, before they do, it also means that investors who take valuations seriously (including us) can expect temporary periods of frustration.

I’ve long noted that the analysis of market action can help to overcome some of this frustration, as stocks have often provided good returns despite rich valuations so long as market internals were strong, and the environment was not yet characterized by a syndrome of overvalued, overbought, overbullish, and rising yield conditions. In hindsight, the stock market has followed this typical post-war pattern, and we clearly could have captured some portion of the market’s gains over the past year had I ignored the risk of a second wave of credit strains (which I remain concerned about, primarily over the coming months).

It is important to recognize, however, that even if we had approached the recent economic environment as a typical, run-of-the-mill postwar downturn, we would now be defensive again, as a result of the current overvalued, overbought, overbullish, rising yields syndrome. I do recognize that my credibility in sounding a cautious note would presently be stronger if I had ignored further credit risks and captured some of the past year’s gains. But the awful outcome of this same set of conditions, which we also observed in 2007, should provide enough credibility.

Hussman proceeds to offer a detailed statistical analysis of how valuation and market action impact risks and returns. Curious parties are encouraged to read his essay in its entirety.

Here is how he rather bluntly sums up the current environment:

As of last week, the Market Climate in stocks remained characterized by an overvalued, overbought, overbullish, rising-yields syndrome that has historically produced periods of marginal new highs, slight declines, and yet further marginal highs, followed somewhat unpredictably by nearly vertical drops. I’ve often accompanied the description of this syndrome with the word “excruciating,” because the apparent resiliency of the market and the celebration of each fresh high, can make it difficult to maintain a defensive stance. Interestingly, the analysts at Nautilus Capital recently noted that the most closely correlated periods in market history to this one were the advances of 1929 and 2007. While exact replication of those advances would allow for a couple more weeks of further strength, we’ve generally found it dangerous to expect history to do more than rhyme. These hostile syndromes have a tendency to erase weeks of upside progress in a few days.

I have to agree with this assessment as well as that of Robert Prechter that this spring offers perhaps the greatest short-selling opportunity in history.

Hussman sees danger ahead

Top-performing mutual fund manager John Hussman sees no value in this “overvalued, overbought and overbullish” market.

Last week, the dividend yield on the S&P 500 dropped below 2%, versus a historical average closer to double that level. While part of the reason for the paucity of yield in the current market can be explained by the 20% plunge in dividend payouts over the past year, as financial companies have cut or halted dividends to conserve cash, the fact is that current payouts are not at all out of line with their historical relationship to revenues, and even a full recovery of the past year’s dividend cuts would still leave the yield at a paltry 2.5%. The October 1987 crash occurred from a yield of 2.65%, which was, at the time, the lowest yield observed in history, matched only by the 1972 peak prior to the brutal 1973-74 bear market.

Those two periods had a few other things in common. In the weeks immediately preceding the market downturn, stocks were overbought, had advanced significantly over prior weeks, bond yields were creeping higher, and investment advisory bearishness had dropped below 19%. All of those features should be familiar, because we observed them at the 1987 and 1972 peaks, and we observe them now…

So when will we accept more risk? Easy – when the expected return from accepting risk increases, or when the expected range of outcomes becomes narrower. Presently, two things would accomplish that. One is clarity, the other is better valuation.

First, and foremost, we have to get through the next 5-6 months, which is where we will at least begin to see the extent to which “second wave” credit risks materialize. We emphatically don’t need to work through all of the economy’s problems. What we do need, however, is for the latent problems to hatch, so we can have more clarity about what we’re dealing with. I’m specifically referring to the second round of delinquencies and foreclosures tied to Alt-A and Option-ARM loans, the requirement beginning in January that banks and other financials bring “off balance sheet” entities onto their books (which, as Freddie Mac observed in a recent footnote, “could have a significant negative impact on its net worth”), and the disposition of a mountain of mortgages that have been increasingly running delinquent, but where foreclosure has been temporarily delayed.


Hussman’s fund doesn’t go net-short, but past times when he’s gone fully-hedged have been good opportunities to think about short selling.

Earnings check: quietly revising down

Here’s a snapshot from the latest S&P 500 earnings file (paste the following link into your browser or google “S&P 500 earnings” for the whole Excel file: www2.standardandpoors.com/spf/xls/index/SP500EPSEST.XLS):



















The average estimate for 2009 earnings is now under $40 (for a PE of 27 using today’s price), since Q3 and Q4 have been revised way down from earlier this year. Now analysts think Q4 could only come in $1 better than Q1, which was horrible.

These numbers make you wonder if accountants used up all of their tricks to boost the bottom line in Q2. The reality of shrinking sales and margins can’t be hidden forever.

The estimates for 2010 and 2011 earnings are now $45 and $61, respectively, and 2009 dividends are projected at $22 (back to 2005 levels from $28 in 2008, for a piddling 2% yield). Even if profits recover as projected, the market will have to maintain the current extreme multiple in order to deliver gains over the next two years. We are already trading at 18X 2011 earnings! The PE at the peak in 2007 was 19, and look at where that got us.

My own take on earnings is that we will be lucky to see $30 in 2010 or 2011 for that matter. The debt overhang remains, and underlying asset values are so much lower than they were 12 months ago that another huge round of write-offs is needed, which will directly hit the bottom line. Households are digging in, and banks are still pulling in credit. The consumer economy is not coming back, and corporate America will take years to adjust.

Stock prices are so far from fundamental support of any kind that this market has to be counted among the greatest bubbles of all time. Many observers understand that this is a bubble, and are wondering what it will take to bring prices back in touch with reality. My answer is nothing — the market will simply turn with social mood, which has no master but god. The facts are always there, but traders aren’t always in the mood to check.


Valuation still matters

Many great traders could care less, but investors need value, and there has been none in the US stock market as a whole since about the early 1990s, and no great value since about 1984. Value means getting a lot for your money, and in stocks that means of course earnings, dividends and (honestly priced) assets.

David Rosenberg is about the only bearish mainstream economist left, all the others having drunk too much Keynesian cool-aid and succumbed to the fallacy that Fed printing and government spending is stimulative (is is the opposite). In this morning’s Breakfast with Dave he warns again that fundamental or long-term investors have business touching the stock market at these prices:


Never before has the S&P 500 rallied 60% from a low in such a short time frame as six months. And never before have we seen the S&P 500 rally 60% over an interval in which there were 2.5 million job losses. What is normal is that we see more than two million jobs being created during a rally as large as this.

In fact, what is normal is for the market to rally 20% from the trough to the time the recession ends. By the time we are up 60%, the economy is typically well into the third year of recovery; we are not usually engaged in a debate as to what month the recession ended. In other words, we are witnessing a market event that is outside the distribution curve.

While some pundits will boil it down to abundant liquidity, a term they can seldom adequately defined. If it’s a case of an endless stream of cheap money, we are reminded of Japan where rates were microscopic for years and the Nikkei certainly did enjoy no fewer than four 50% rallies and over 420,000 rally points in a market that is still more than 70% lower today than it was two decades ago. Liquidity and technicals can certainly touch off whippy tradable rallies, but they don’t take you all the way to a sustainable bull market. Only positive economic and balance sheet fundamentals can do that.

Another way to look at the situation is that when you hear and read about “liquidity” driving the market, it is usually a catch-all phrase for “we have no clue” but it sounds good. When we don’t have a reasonable explanation for what is driving prices our strategy is to watch from the sidelines and express whatever positive views we have in the credit market and our other income and hedge fund strategies.

I wholeheartedly agree with his take on the word liquidity as it is thrown about these days. All it really seems to mean is that people are bullish and in the mood to take on risk — most assets were perfectly liquid throughout the crash (that is, there were plenty of buyers), packaged mortgage debt included. The banks only pretended their assets were unsaleable because they didn’t like the bids, which, as it turns out, were perfectly reasonable given the reality of default rates and shrinking collateral values.

Rosenberg goes on to discuss exactly how ridiculous the valuations are, even given the extremely rosy earnings forecasts, which seem to imply that Goldilocks was only taking a little nap and that it is not true that she was torn to shreds by the bears:

As for valuation, well let’s consider that from our lens, the S&P 500 is now priced for $83 in operating EPS (we come to that conclusion by backing out the earnings yield that would match the current inflation-adjusted Baa corporate bond yield). That would be nearly double from the most recent four-quarter trend. Not only that, but the top-down estimates on operating EPS, for 2009 are $48.00 for 2009; $52.60 for 2010; $62.50 for 2011; and $81.00 for 2012. The bottom-up consensus forecasts only go to 2010 and even for this usually bullish bunch, operating EPS is seen at $73.00 for 2010, which means that $83.00 is likely a 2011 story. Either way, the market is basically discounting an earnings stream that even the consensus does not see for another two to three years. In other words, this is more than just a fully priced market at this point.

It is, in fact, deeply overvalued at this juncture. Imagine that six months after the depressed lows we have a situation where:

The trailing price-earnings ratio on operating EPS is 26.5x. At the October 2007 highs, it was 18.8x. In addition, when the S&P 500 is trading north of a 26x P/E multiple on trailing operating earnings, history shows that at these high valuation levels, the market declines in the coming year 60% of the time.

The trailing price-earnings ratio on reported EPS is 184.2x. At the October 2007 highs, it was 23.4x. In fact, just prior to the October 1987 crash, the P/E ratio was 20.3x (not intended to scare anyone).

The price-to-dividend ratio is 53x, where it was at the 2007 highs. Again, the market is trading as it if were at a peak for the cycle, not any longer near a trough. Once again, and we don’t intend to sound alarmist, the price-to-dividend ratio just prior to the 1987 crash was 12x, and at the time, the S&P 500 was viewed in many circles to be at an extended extreme.
Bullish analysts like to dismiss the actual earnings because they are “depressed” and include too many writeoffs, which of course will never occur again. Fine, on one-year forward (operating) earning estimates, the P/E ratio is now 15.7x, the highest it has been in nearly five years. At the peak of the S&P 500 in the last cycle — October 2007 — the forward P/E was 14.3x, and the highest it ever got in the last cycle was 15.4x. So hello? In just six short months, we have managed to take the multiple above the peak of the last cycle when the economic expansion was five years old, not five weeks old (and we may be a tad charitable on that assessment). As an aside, the forward multiple on the eve of the 1987 stock market collapse was 14x and one of the explanations for the steep correction was that equities were so overvalued and overbought that it was vulnerable to any shock (in that case, it came out of the U.S. dollar market). It certainly was not the economy because that sharp 30% slide took place even with an economy that was humming along at a 4.5% clip.

The entire article (sign up for emails) is worth a read. There is much more good stuff in there on housing, manufacturing, commodities and household net worth. Savvy contrarian that he is, he also had these kind words to say about the US dollar:

We do not like the U.S. dollar at all, but at the same time, from a purely tactical standpoint, we have to recognize that there are no U.S. dollar bulls out there right now, the bearish dollar trade is the crowded consensus trade, and that the greenback is massively oversold. It could snap back near-term — be aware of that, please.

The reality of S&P 500 earnings

To say that stocks are anything other than dangerously overpriced with a P/E of over 130 and a yield of 2.5% on unsustainable dividends is either farcical or fraudulent.


For such a simple little metric, the P/E ratio is subjected to all kinds of perversions to deflate it to levels that can be passed off as reflecting value. At the very least, most bubbleheads try to make it less scary than its current level of 133 for the S&P 500.

Do-it-yourself P/E and dividend analysis

It is very easy to find out what the real index PE is at any given time. Just google S&P 500 earnings, and right at the top you will see a link to an Excel file on S&P’s website. Download it and see the data for yourself. The file provides 20 years of history on operating earnings, “as reported” (net) earnings, and cash dividends for the benchmark big-cap index.  Here is a permalink to the latest Excel file.

When talking P/E ratios, look at “as reported earnings,” which are the real bottom line, or as close as today’s accounting methods get to it. “Operating earnings” are all the rage these days with the sell-side and CNBC crowd, since they of course are higher, as they don’t include pesky items like depreciation, taxes and interest. Even more ridiculous is the use of “forward operating earnings,” which are not an accounting entry at all, but just what Wall Street analysts are telling the public that companies might report in future quarters and fiscal years.

To get the real P/E, the one that has been used as a gauge of value for decades, take the sum of the last four quarters of “as reported earnings”. Through Q1 09, for which 99% of companies have now reported, the index has earned a 12-month total of $6.87 (with the index at 915, the P/E is 133).

An S&P analyst has noted in the file that if Q3 comes in as expected, trailing 12-month earnings will be negative for the first time in history (I bet CNBC will decide to ignore that little factoid, since it’ll be a hard one to spin). Earnings are down from an all-time 12-month peak of $84.95 as of Q2 2007. To be fair to the bulls, the current figures include a loss of $23 in Q4 2008, when financial companies took their write-downs, though surely more of the same are on the way, and not just for banks.

Today’s earnings vs. recent history

Q1 2009 earnings were about $7.53, and Q2 and Q3 are expected (analysts tend not to be that far off for quarters directly ahead) to be more or less the same, so we are on pace for about $30 in annualized earnings. A glace at the historical data shows that this is about the same level as in 2001-2003, after a peak of $48-54 for a few quarters in 1999 and 2000. You have to go back to 1994-1995 to again see the $30 level, with the $20 level about the norm from 1988-1993. Assuming that the $30 is sustained, you could say that the current P/E is 30. That’s not value in anyone’s book.

Dividends from la-la land

One particularly striking fact in this data is that 12-month dividends have hardly budged from record levels, coming in at $27.25 as of Q1 2009. Dividends had been growing fairly moderately and steadily from 1988 to 2005, increasing from the $9 to $20 level over 17 years. At the height of the credit binge, companies were flush with cash to give away and buy back stock at inflated prices, rather than pay down the debt they took on to generate those temporary earnings. That they are continuing to pay these high dividends says to me that managers are in total denial or are playing charades to maintain the illusion of health.

The index only yields about 2.5% on current dividends, but if dividends fall back to just 2004 levels, the yield would fall under 2% if the index still trades at 900. Keep in mind that secular bear markets bottom by enticing with high cash yields, as investors by then are too pessimistic to expect much in the way of capital gains. At the 1930s and 1970s bottoms, the market yielded over 10% and 7%, respectively. Just a 5% yield on 2005-level earnings ($20) would be the 400 level on the index. A 7% yield on 1998 yields would mean the index trades under 250.

Whether you are a deflationist or inflationist, you have to admit that a strong dose of either would not be kind to equity valuations. In the ’70s, people demanded high current yields because future yields were so heavily discounted by inflation, and in the ’30s, stock valuations became extremely depressed as earnings tanked and investors panicked.

A crude indication of solid stock values is when the S&P 500 yields over 5% and the P/E is under 10. Stocks can get cheaper than that, but at those levels you really can buy for the long run. To say that stocks are anything other than dangerously overpriced with a P/E of over 130 and a yield of 2.5% on unsustainable dividends is either farcical or fraudulent.


For reference, here is a link to S&P500 earnings and dividend data going back to 1960.

Glancing at the typical ratio of earnings to dividends, if the index is earning $30, one should expect dividends to be about $10-20. There is no record here of another time when dividends were higher than earnings, as they are at present. This says to me that the sustainable yield today is not even 2.5%, but more like 1% to 1.5%, comparable to the peak of the peak dot-com bubble.

From this level of overvaluation in the face of declining fundamentals, stocks could fall hard for another 18 months to restore value fast (1929-1932 model), in which case the 200 level is likely by 2011.  Another outcome is to trade in a range for a decade or more and wait and hope for a bout of moderate inflation to increase the nominal bottom line (1968-1982 model). A third possibility is the Japanese model, where the S&P would get to 200, but over 20+ years. Long-time readers know that as a deflationist and Elliott waver I expect the first outcome, with the most stunning phase of the bear market soon to come.

My screen is still cluttered with overpriced stocks.

This bubble was so extreme by any standard but Tulip Mania, that even after a 40% fall, the exchanges are full of junk stocks priced to go down another 40-100%. Where are the earnings? Where are the dividends?

Here are some prime examples:

  • Home Depot. How on earth is this company supposed to make money in the future? It is still priced at 10X last year’s earnings, and we were just entering a recession then. What will they do in the depression?
  • Blue Nile. It’s a great business concept, but how many diamonds are going to sell at retail next year, and the year after that, and after that? How do you put a 38-handle on last year’s earnings when the business is toast and they don’t even pay a dividend? Also take a look at Zales and Tiffany while you’re at it.
  • REITs, poor REITs. Kind of hurts to have to service all that debt with tenants dropping like flies. Expect zero equity to bring zero bids on a few of these before 2009 is out. Many are still down less than 50% from the crazy prices of 2006.
  • FedEx. Still a trailing PE of 20 and dividend yield at 0.6%! That’s a long ways from value. The stock ought to be priced at 5X last year’s earnings, because they will be lucky to see any next year.

I could go on and on. Stocks are still ridiculously overpriced. If you have Buffett-esque skills, you might be able to find the needle in the haystack that will hold up from here, but why swim against the tide? Your cash goes up in value every day.

Brave New World

The world from 2008 forward will be completely different than the last 60 years. Enormous shifts are taking place that will disrupt every business model and interrupt earnings in a major way. That has only begun to be discounted. This is not 1929, which was just a setback in the growth of western civilization. The utter economic cluelessness of the elite and middle class alike is paving our road to serfdom. My advice to anyone who doesn’t want to live in a Huxley or Orwell novel is to make like Jim Rogers and head east.

Ooff! Bummer for Whole Foods shareholders

The grocer is trading down 19% after hours on news of 24 cents in fully-diluted earnings last quarter and projections for full year profits of 93 to 95 cents.  They also halted their dividend and announced that only 15 new stores were in the works for 2009, down from up to 30.

The stock is down from over $70 two and a half years ago, but is still expensive at 20 times earnings with no yield. Why would you buy a high-end grocer at this point in the credit cycle when it doesn’t even pay a dividend? Aren’t dividends what grocery stores are for, anyway?

Disclosure: this post is a bit of a brag, since I bought puts last summer and am holding pat.