Is a 50% Market Decline Possible?

Before we get stuck into today’s Markets and Money, just a reminder to watch out for a special report from Gowdie Family Wealth editor Vern Gowdie tomorrow. Vern makes some pretty big claims. We won’t go into it here, but if you think we’re bearish, check out Vern’s well-reasoned analysis for a comparison.

Not that we’ve gone soft or anything. In fact, we’re just putting the finishing touches to our latest issue, wherein we make the case that a 50% fall in the S&P500 is not only possible over the next few years, it’s entirely probable.

That may sound extreme, but it’s happened plenty of times before. It happened after the 2000 tech bubble and after the 2007 US housing bubble. It also happened after the long post-Second World War boom ended in the late 1960s.

Amid investor euphoria following two decades of solid gains, the market topped out in December 1968. While most market players were completely ignorant of the coming six year decline that wiped 50% of the value of the S&P500, there were a few people who could see what was coming.

One of them, known only as the ‘Gnome of Zurich’, saw rumblings in the gold market as a sign of things to come. He was ringing the bell for the top of the market while Wall Street investment whizzes continued to trade bits of paper with each other.

So is another washout likely? We reckon it is, and there are rumblings in the gold market too. Although we’ve been saying that a big correction is likely for a while. On the other hand, our mate Kris Sayce over at Money Morning reckons the market will keep going up. He says there will be corrections from time to time, but the general trend is up.

And we can’t disagree there. The trend is up…at the moment. But trends change, and we think the market is going through a major topping out process.

Many people have a problem with the fact that we don’t all share the same view here at PPP headquarters. But that’s what makes a market. In addition to the robots (who seem to be accounting for more and more of the trading volume these days) the market is just the collective force of millions and millions of individual investment decisions.

Opinions form these decisions, and biases form opinions. So whenever you hear someone form an opinion about the market, ask yourself, what is their personal bias? We can’t speak for Saycey, but we know our own biases well. As a value investor, we only want to buy stocks when they are good value relative to the risks involved. So we have a strong bias to want to see lower stock prices from here.

Judging risks and value is always a subjective call. Risk, like beauty, is in the eye of the beholder. That’s why we (and Vern) like cash right now, while many others are doing anything they can to get out of cash and into dividend paying stocks.

We see the risks as being too high to justify a large exposure to the market. So we wait it out in cash. It’s not that we’d prefer cash, but the alternatives are unpalatable. Our bias is to want to invest in cheap stocks…that is, companies that will, over the long term, reward you for the risk of being an equity owner in an unpredictable business.

And at current prices, we just don’t think the long term owner of a business is going to receive an adequate reward for the risks involved. It’s as simple as that.

Central banks are forcing you to take risks which mean you’re really speculating that they can continue to force new people into the market, pushing prices higher and higher. Well, that dynamic has been in force for years now. We’re not certain that’s there’s many more marginal investors to keep the buying pressure up.

More importantly, this investment behaviour actually supports lower prices over the longer term. Take the recent Aussie reporting season. One of the main themes was an increase in the dividend payout ratio. That is, companies are reinvesting less into their businesses and giving more to shareholders.

So instead of increasing their net worth through reinvestment (and compounding those reinvested funds) a higher proportion of company earnings go to investors, who either buy more stock with it or consume it.

If you think about it, this is not good from a long term perspective. If companies don’t reinvest then it makes it hard to generate sustainable earnings growth. Without earnings growth you get little to no growth in intrinsic value. So even though reinvested dividends might push up share prices, the intrinsic value of the company isn’t increasing, and it may even be falling.

A higher share price with little to no earnings growth simply reflects a stock getting more expensive.

We’re generalising here to make a point. The point is that higher dividend payout ratios might sound good to shareholders thirsting for income, but it undermines a company’s long term intrinsic value by having the board make capital management decisions to satisfy the short term demands of investors rather than the long term demands of the business.

Before we sign off we’d just like to highlight the astounding fact that we didn’t make one disparaging comment about China this week. That must be some kind of record. We haven’t changed our views, but the story is becoming a little mainstream now.

This week, both the Wall Street Journal and the Financial Times published a series on China’s debt woes. When that happens, the turmoil tends to quieten down for a while. But we expect more problems to emerge in the months ahead. We’ll be sure to let you know about it too!

Have a good weekend…


Greg Canavan+
for Markets and Money


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From the Archives…

Richard Fisher’s ‘Super Easy’ Fed
23-08-2013 – Nick Hubble

US Stocks and the Timeless Wisdom of Izzy Stone
22-08-2013 – Chris Mayer

Bankers Profit at the Expense of the Broader Community
21-08-2013 – Vern Gowdie

A Bond Market Tantrum

20-08-2013 – Nick Hubble

Australia’s Economy: Complex, Fragile or Centralised?
19-08-2013 – Nick Hubble

Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:


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