By: Claus_Vogt
Since its low in March 2009 the S&P 500 Index has doubled. Last week The Wall Street Journal stated that it was the fastest doubling since 1936. That rally began in March 1935 and reached the 100 percent gain mark in 501 days. The red vertical line in the chart below depicts the start of the rally.
This time the market needed a bit longer to double … 707 days.
What the Journal did not mention was what happened afterwards. Let’s fill that gap, since the rest of this story is as interesting as the first part …
Immediately after the index doubled in 1936 a short-term correction followed. But then the rally reassured itself. It lasted another seven months and gained 15 percent. However, that was the end of the party as you can see in top panel of the chart.
The S&P 500 experienced 40 percent slump the following year. But the final low of this bear market came as late as 1942. Many analysts conclude that 1942 marked the real end of the Great Depression.
An Interesting Analogy
I see an interesting analogy here since the bull market of 1936-1937 followed the most severe financial crisis in U.S. history, and the current rally follows the second-most severe one.
In 1936 hopes ran high that the crisis was over and a sustainable recovery had started. But as it turned out the economic slump was only interrupted. Another grave economic downturn started in May 1937 and lasted until June 1938 with GDP declining 3.4 percent. Only the outbreak of WWII put an end to the Great Depression.
As in 1936 hopes are again running high that the Great Recession and the associated crisis is over and that a sustainable rally has started. This may also turn out to be a false hope. Why?
Well, the underlying problems of overindebtedness have not been solved — not even addressed. Quite to the contrary. All that has happened is the government stepping in and shifting some of the most pressing debt loads of financial institutions from the private sector to the public sector.
That’s not a solution; it’s kicking the can down the road!
Fundamental Valuations Are High
Now look at the middle and bottom panels of the above chart. The middle one shows the price/earnings ratio, the second one dividend yields. Both are time honored measures of valuation. First you can easily see that current valuations are very high.
Then compare 1937 to today. In 1937 the price earnings ratio was a tad lower than now. But the dividend yield was higher at 3 percent then vs. 1.7 percent today. Obviously, the stock market is no healthier now than it was in 1937.
Let’s summarize the main points: In the mid-1930s the stock market and the economy were recovering from a major crisis, and the stock market was clearly overvalued. The majority of market participants and economists were sure a sustainable recovery had just begun.
Their hopes were quickly dashed.
Will it be different this time around? Probably not because we’re in the same boat today: Recovering from a major crisis, an overvalued stock market and high expectations.
Plus there are other signs warning of a high risk environment …
Fund Managers Fully Invested, Short Interest Drops; Insiders Selling Stock!
First, mutual fund managers are again fully invested with an average cash quote of a mere 3.5 percent. This is the lowest reading since this data series began in 1988. Only once before — in March/April 2010, just before a 20 percent correction — has this indicator been so low. Even at the major highs of March 2000 and October 2007 fund managers were more cautious than now.
Second, the NYSE Short Interest Ratio has fallen from 4.1 in December to a very low 2.6. This ratio measures the total outstanding shares sold short divided by the average daily volume for the last month. Its interpretation is twofold …
A low short interest ratio is a sign of widespread bullishness or at least complacency. Even more important is the fact that short sellers are potential buyers in case of a market slump. To realize their gains they have to buy back the shares sold short. So the massive decline in shares sold short means there will be fewer buyers in the future.
Third, financial insiders are massively selling the stocks of their companies. Alan Newman of Crosscurrents shows that 68 sellers were matched by just four buyers. And the ratio of shares sold to shares bought was 855.
So why are the insiders of Goldman Sachs, Wells Fargo, JPMorgan, Morgan Stanley, American Express, Citigroup, and US Bancorp selling like mad? They apparently have some doubts in the health of the current rally — at least insofar their own money is concerned.
You don’t have to sit on the sidelines if the market takes the header I see coming …
One way to profit from a declining market is with an inverse ETF, like ProShares Short S&P500 (SH). This fund seeks daily investment results that correspond to the inverse of the daily performance of the S&P 500 Index. That means you stand to make 1 percent for every 1 percent the Index drops.
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