If the Stock Market Is Overpriced, Why Isn't Anybody Warning Us?
For some reason, there seems to be no hue-and-cry about the precariously swollen stock market--just the usual business-as-usual discussion about bottom-fishing for stocks that have been oversold during the bear market of 2000 - 2001. You don't suppose that's because $100,000,000,000 a year is riding upon keeping things on an even keel, do you? You don't suppose that just because someone is dependent upon a stable stock market for his salary, his family's Christmas presents. and dental coverage for the kids' orthodontist, he would hesitate to blow the whistle and expose the situation for what it is even if it cost them his job, do you? Naw! No way!.
How HIgh Could the Stock Market Go Without Really Going Anywhere?
Suppose that somehow, the stock market holds together through 2004. How high could it go without passing beyond the already-illicit values of dividend yield and and price-to-book ratios?
If we assumed 3% per year inflation, and added to that the glacial 1.2% annual rise in the market indices over the 4-year span from 2000 to 2004, that would amount to about an 18% increase from its March, 2000, value of 11800 on the Dow, or about 14000 on the Dow. Measured from its present level of about 10000, that would look pretty good (a 40% "gain" over two years), and yet, all but 500 points of it would be inflationary puff.
One interesting way to interpret this is to add the 1.3% annual dividend yield to the 1.2% annual rate of rise market averages over time. This would give us an definitely sustainable 2.5% rate of return on the Dow. The only problem is that the rate of inflation is 3% per annum.
But... Within a Few Months, Interest Rates Are Going to Start Climbing Again
At the same time, interest rates are going to start to climb sometime between June and December (depending upon who tells it). Higher inflation rates tend to mean lower stock market yields, and will also signal a pullback by 2006. The stock market will anticipate this, and will respond preemptively before the slowdown actually occurs. (In fact, its very rise may be moderated by the sure knowledge that a slowdown is coming again in 2006.)
A maximum value of 13000 might be a reasonable expectation, given the known-to-be-ephemeral nature of the impending recovery. That would also be consistent with the kind of lower-and-lower peaks that attend a super-bear market decline. However, given the unprecedented overvaluation that has already occurred in the U. S. stock market, it would seem to me that a catastrophic crash could occur at any time. We've had a superb environment for the stock market, with low inflation, rapidly rising earnings, and a population of inexperienced investors investing for their retirement. (This will be the first generation which has managed their own retirement portfolios, rather than letting pension funds, with their professional managements, do it for them.) These investors haven't the time to become deeply knowledgeable about their investments the way professional management teams have in the past. Anything can happen.
Any kind of sustained trauma such as a war could collapse this house of cards. It depends upon a continuation of better than average good news for its existence. Alternatively, if small investors get Money Magazine's news about our having entered a super-bear market, they may not be so quick to sit and hold their investments. Given 14 more years of steadily declining investment values, they might begin to become suspicious that something isn't quite right.
How Much Would the Stock Market Have to Drop to Reach Bottom By 2016?
I'm glad you asked! Let me see now... Let's suppose that it dropped by a factor of 6, while rising, because of inflation and a long-term rise in the Dow, by 4.5% a year. At its bottom in 2014, it should touch 4000, before starting its long climb above 100000 in 2032.
My (Tentative) Personal Strategy
My personal strategy will be, as I mentioned night before last,: to sell funds that have returned to, or have closely approached their year-2000 peaks, and then to investigate further options with experts who know more about this than I do..I also certainly plan to seek validation of these interpretations I've dreamed up before I bet the farm on them, or recommend them to anyone else.