>Can you define (a simple percentage will do) what you would accept
>as a 'crash' ...?
A fast and big change. So the duration of the event is also a point. I would say that for instance > 10% in a couple of hours is a crash. Would you call that a "correction"?
>Let's try something simple: do you think the
>DJIA will see 6,000 before it sees 12,000?
>Don't forget that a DJIA
>6,000 is just taking us back to November '96, barely a year and a
>half ago.
I do not hold that a crash is something that neccessarily takes the stock price down to P/Es of 12 to 14. It suffices with a sharp and big, in the *relative* sense of the adjective, drop. I do not see a crash as an event so immense that it "resets" the price back to fundamentals (you seem to imply that that is my position), but more as an event that gives a shock to the market, changes the fundamentally optimistic mood to qualitatively more pessimistic, and possibly initiatites other events that may unravel the economy, like in 1929. Btw, my generic stock market model generates all sorts of crashes between 5% to 35%.
>The "crash" of '29-33 took nearly thirty years to erase.
There were some other happenings in between too, but OK. The 1929 crash was the initiating event of the Great Depression, not its explanation. You may perfectly well have a stock market crash without an ensuing depression. On the other hand a world depression *is* a possibility, also today.
>> >(Battapaglia:) Market valuations are justified because they are not
>> >anticipating better times...we're in better times.
>
> ......................I think he means that the justification
>for the current levels does not come from people hoping for better
>times; his claim appears to be that the 'better times' one might
>hope for in some other scenario have actually happened. So the risk
>that we don't actually attain those hopes is not in the equation; in
>a sense, we're already there. I think this is what Doug said earlier.
I understand Doug to say that the mood now is *extremely* short-sighted (in the time horizon sense). He doesn't comment on my proposition that the market has to be fed persistently with rising prices to keep up the current mood, at least to keep it up over some time (several months). I hold that any levelling off in price increase rate in a situation far above historic P/E rates (which reflect "fundamentals") sets in motion a positive feedback process for even more levelling off, and in the next round, falling prices. This is all about psychological group dynamics, and the situation today is comparable to a pyramid game in its late euphoric phase, when a minority is starting to have second thoughts, but an increasing one at that.
>Again, as he is a feverent bull, I'd believe his outlook is for the
>market to move higher. In fact, DJIA 10,000 seems easily attained by
>the middle of summer.
Possibly.
>> When prices flatten out, the only factor remaining to support the
>> price level of stocks, is the earnings, which at this P/E level
>> are obviously to low in relation to prices.
>
>I'm sure many would argue with you on this point; in particular,
>the issues of supply and demand are still at play.........
As long as you have a market, the issues of supply and demand are at play. This has no bearing on our discussion.
>.........even if the momentum appears to stabilize.
That is an important statement. If you by this means that the euphoric mood is starting to taper off, then the unavoidable process of culmination is developing, opening up for panics/crashes with increasing probability.
>Getting back to the political aspect of this, I believe that at least
>part of this bull market has been engineered to incent workers to
>take part in "owning" the responsibility for their retirement. The
>tax code changes since the mid-80's and simultaneous Fed policies
>of lowering interest rates and unemployment have led to both a
>decrease in collective labor power (who wants to strike if it means
>taking time out from participating in the 401k plan?) and a radical
>increase in the demand half of the equation in the equity markets.
>Add to this the fact that total supply of stock is down (due to
>M&A activity, principally, but fueled by stock buy-backs and to
>a smaller extent employee stock option exercise), and you've got
>a "magic" environment where, without a viable alternative, there's
>no 'good' reason to see the markets go down.
This seems reasonable. The extraordinary long-term and strong growth in U.S: stock prices is due to the amount of fresh money persistently injected into the market. But surely there must be *some* limit to the share of American aggregate cash flows that can be allocated for the financial market?
>These actions have helped to alter the "normal" behavior of stock
>prices; the day after a big crash, everyone wakes up with a new
>slice of retirement savings that has to be invested. Will they
>suddenly stop investing it? The cash has to go somewhere. Many
>of these people believe that buying mutual funds is now their
>civic duty.
Yes, this seems to be the mood FOR THE TIME BEING. You describe the situation as very much psychology- and mood dependent, which I agree to. But psychology/moods are extrmely unstable phenomena. What will happen if a significant share of the U.S. population sooner or later loses a large chunk of their life savings, or - as a first step - starts to *fear* such a loss (which in itself is enough to start the process)?
>> .... Why do you think the market is so much more
>> nervous now than a couple of years ago?
>
>Nervous? I'm not sure where you see it from, but I'd say it's
>downright giddy. Perhaps scarilly so. Ordinary folks *loving* the
>idea of a dip in the market, seeing it as a buying opportunity.
Of course you find different attitudes. But a growing crowd of media commentators and other pundits is sounding off warnings, recently among them the director of the Australian Fed. Such warnings are not only to be taken as opinions, they influence the mood and may thus turn out to be self-fulfilling prophecies. They are part of the process itself, as are Battapaglias exhortions.
>> Because everyone knows deep down inside that there are
>> some sort of "fundamentals" (or call it what you like) that by
>> today are outrageously violated. Do you deny this?
>
>Do I deny that it's true, or do I deny that people think this?
>
>Well, now that you ask, yes I do deny that there is any kind of
>fundamental support for stock prices. The price to earnings ratio
>is downright hilarious. 57 for MSFT?
I think you contradict yourself here. When you say that a P/E of 57 is "hilarious", that statement must mean that you relate this ratio to some other level that is "reasonable". So you seem yourself to have some idea about there existing some P/E ratio corresponding to an "anchor" or "fundamentals", whatever.
>.....
>Here's another thing I believe: people are naturally long. They
>get up in the morning and hope for the best, they see success as
>something to be attained and up as the direction to head in.
"Naturally", meaning at all times, i.e.due to genetic traits? I would rather say "in today's euphoric mood". What about the U.S. public mood in the thirties?
> It's probably the reason so many people buy stock hoping it will go
>up rather than sell it hoping it will go down.
You don't mention this alternative: When they sell they may do it because they want to get out now to avoid losing even more if they wait any longer. A panic.
>> Why should an investor buy stock at a price which gives a risky
>> return on his investment at the puny magnitude of -say- 3%, when
>> he can buy risk-free gvt. bonds or even deposit his money in the
>> bank at higher rate of return?
>
>I'm not sure if this is a setup, but in the last two years the
>average equity fund in the US returned well over 20%; show me a
>govt. bond that pays 20% (ok, Mexico doesn't count - I mean one
>with little currency risk) and I'm sure I'll be interested.
If the major part of this extreme return rate is due to stock appreciation, as opposed to earnings based on firms' sustainable economic activity, then this is not an answer to my point above.
>In fact, find me a *corporate* bond that pays that much, and I'll
>be interested.
I am not. I take a political stand against work-free income, i.e. all sorts of financial accumulation. Financial accumulation with ensuing macroeconomic polarization and relative increase in debt/asset-related cash flows is also dangerous for the macroeconomy.
>> Any stock is overvalued when the P/E is so high that the risk
>> premium + gvt. security return rates are higher than the return
>> rate on the stock.
>
>That's a nice heuristic, but so far you're dead wrong. I mean, if
>you have a good way to evalute "risk premium" in this market, you're
>wasting your time at University.
You must not assume that anyone that has a recipe for making money through financial transactions are wasting their time if they choose not to. That said, I have no such recipe, my model can only be used to (hopefully) gain some insight into the general mechanics of a stock market, not to predict exactly when and what will happen.
>Another thing that needs to be
>taken into account is sector rotation; the market is so incredibly
>liquid that sector rotation is possible even among individuals. So
>who cares if yesterday's stock is overvalued? Switch to today's
>high flier and win some more.
How long can this state of affairs persist?
>> Concerning the stock market, I could just as well go to the
>> Sydney Casino and play black jack.
>
>Keeping your own proclivities out of the equation for a minute, ...
I think it is fair enough to signal some attitude. You did the same when you automatically assumed that anyone who had the talent for winning in the financial markets were wasting their time if they didn't.
>...why are you so sure that we're going to see a crash?
It's simply a prediction based on my understanding of how these dynamics work (which of course may be flawed. If so, I expect people who hopefully read my working paper to point out where I go wrong), and what I get mostly through the media. I say a crash within a year, you say that this can go on indefinitely(?). Both are educated guesses. Time will show.
>....
>Finally: if you're so sure, why aren't you buying puts?
Answered above. Values differ.
Trond Andresen