What’s Next

by Paul J. Lamont, Lamont Trading Advisors, Inc. | April 14, 2010

While our forecast for a U.S. dollar rally proved correct, financial losses in Europe have yet to affect U.S. equities. But it is only a matter of time. As we mentioned two months ago:

“While we prefer the Q ratio, the cyclically adjusted price to earning ratio from Robert Shiller (shown below) accurately reflects the full cycle of stock market expectations. If the market “took investors to the clouds” in 1929, stockholders back in 2000 entered the ionosphere. It should be of no surprise that since that time investors have been continually disappointed.”

As Societe General's Dylan Grice points out: “According to Robert Shiller’s latest data, the S&P500 is back in its highest valuation quintile. The risk is there - as it always is - but the returns aren’t. So what do you do? Go take a holiday if you can.”

The chart below shows the P/E ratio in its highest quintile, which according to Grice implies a 1.7% annual return over the next 10 years.

schiller PE

At these valuations, the stock market reminds us of the 30 yr-Treasury Bond back in December of 2009. At that time, the Treasury was offering investors a mere 2.5% annual return on your money for 30 years. Ninety-nine percent of day traders surveyed thought this was a good deal then. Of course, they were wrong. Bond prices went down 20% and the government now offers a 4.7% yield for 30 yrs. In our view, buying the S&P500 for a 1.7% return over the next 10 years is a similarly bad deal. But the day traders are loving it once again.

‘A Dream That is Not Going To Come True For Any But the Tiniest Fraction’
Warren Buffett once argued against gambling in Nebraska. His points are applicable to Wall Street. As we wait for the stock market to deflate, we offer this quote from John Rothchild:

“By December 30, 1929, the stock market was happily on its way to regaining a third of its losses. Enough confidence was restored that the so-called Crash was knocked off the front page of Barron’s by a crisis in South American Bonds. That the Dow Jones Averages didn’t reach a low point until 1932, three years after the supposedly disastrous date, should be very reassuring to us all. There was plenty of time for the investing public to sell its stock and suffer a normal setback - a 50 percent loss at the most.” A Fool And His Money: The Odyssey of an Average Investor. John Rothchild, 1988.

Unfortunately, few did. Most sold in the Panic of 1932, when the market was down 85%.

Contact Information

Paul J. Lamont | Lamont Trading Advisors, Inc.
502 Bank Street Decatur, AL 35601 | Tel/Fax: (256) 850-4161 | Email | Website