Rauch: Investing

Investing: Greatest Bull of All Time

by George Rauch

On April 20 and April 25, all three Dow averages (Industrials, Transportation and Utilities) closed at simultaneous historic highs. This has happened only a few times in the last 100 years. Additional record highs continued to occur through early June, and during that time, the Standard and Poor's Index of 500 Stocks also established new highs. The S&P 500, confirming the Dow record highs, is an important indication of what is happening to the other 470 companies that are not included in the Dow Jones Industrials. Since early June, the market has had a backing off in price from those highs as the market settles back and takes a breather.

 The market indicates, however, that it will probably continue to set new highs. We are not in a value market. This is a momentum market that shows a striking resemblance to the run-up that began in the late 1990s. 

What's the difference between "value markets" and "momentum markets?"

A market that is increasing from low values is a market that is "cheap." By cheap, we mean that the price-earnings ratios are below historical averages and that dividend yields are above historical average yields posted by the market.

This current market is selling at a price-earnings ratio already 35% over the historical average value of price-earnings ratios. Dividend yields are about 50% of the historical average dividends paid. So the market is certainly no bargain, even though it continues an upward trend.

When an overvalued market, like the late 1990s, continues to increase in price, it is a "momentum market." In other words, there is no mathematical justification for the market's increase.

However, the demand for stocks exceeds the availability of stocks, and the price of securities continues to increase because of the momentum of the public's demand.

 If you say the market is already overvalued, why do you also say the momentum of the market may carry it higher?

Let's list the possible reasons for the market's unprecedented march north:

1. Housing is a large part of the U.S. economy. Inventories are increasing as houses remain unsold. There is hardly any good news at all in the housing sector, yet the market has ingested all of this news, and the market's reaction is, "This difficulty can be absorbed and handled in our economy."

2. The Federal Reserve System continues to print money in record amounts, as Market Watch points out almost every month. The magic formula of keeping both the government and the economy compatibly in business is the mass manufacturing of money by the government to pay bills that taxes cannot cover.

As the public has gotten used to this constant flow of cash into the banks, the public has discounted the dangers involved in having money backed by nothing but the full faith and credit of the Federal Reserve System.

Money in the economy that is printed to cover federal government deficit spending is inflationary because cash is inserted into the economy in excess of goods and services for that cash to purchase.

To keep inflation in balance, the government must issue enough new cash to cover its bills, but not so much that inflation increases out of control.

Our government's inflation target for the economy to remain "under control" is less than 3%. It has been the charge of the Federal Reserve System from the executive branch of the government over the last several decades to ensure there is a lot of cash in the economy.

3. Government tax revenues continue to increase. At current spending levels, prominent economists are predicting that the federal budget could be balanced by 2009 (Market Watch comment: no way!)

4. The Dow transports are not selling off like the rest of the averages. This probably has to do with the components of the Dow Transports being huge international shippers of goods.

Economies around the world with which the United States does business are enjoying a boom in their gross domestic products, their productivities and their standards of living.

The U.S. consumer happily purchases those cheaper goods that must be "transported" around the world. The Transportation Average not tapering off from its record high is an interesting potential indication of a positive business attitude and environment around the world.

Are there any mathematical indications to support your statement that business around the world is good?

There are 17 different major stock markets around the world that Wall Street follows. All of these markets are up, some are setting records like our own markets and all of them are selling above their 200-day moving average. We do not know if this has ever occurred before. That's how rare this set of circumstances happens to be.

The conclusion is that buying momentum in stock markets all around the world is up. There is no indication that such demand will not continue. If it does, and the retail investor gets involved, a run-up of this market similar to the one in the late 1990s would take the Dow Industrials to more than 20,000 points.

That's would be a 45% gain from current levels. Does that mean in a momentum market, you can't lose money?

You can lose money in any market. In fact, most of the people you come in contact with do manage to lose money in bull markets. The possibility of losing money is lessened in a bull market, but doing something stupid can cause people to lose money any market.

What would be stupid?

Going into debt that cannot be handled is not smart. Buying stocks on margin is too risky. Buying just any stock is not smart, and listening to your neighbor's hot tips, or even your broker's, can be costly. One must be discriminatory in the investments he makes in all markets.

What investments could be made that will keep us from losing money?

There is no investment guaranteed to keep one from losing money. However, there are securities to be purchased that are selling at great values in almost any market. Last month Market Watch listed several securities that are selling at their historical lows. They are priced below the Dow Industrial's historical price-earnings ratios. Some of those Dow companies are Bank of America, Citigroup, Home Depot, Johnson & Johnson, McDonald's, Pfizer, Proctor & Gamble and Wal-Mart. Purchasing value stocks lowers the downside potential of an investor's portfolio. Similarly, a large market increase from these levels could yield an investor a big return because such stocks are cheap.

What are we to conclude?

The fate of the world economy really rests on the shoulders of the American consumer. He must continue to consume, and right now, the American consumer is accommodating the world's economy. As foreign economies progress and mature, their own consumers add to the momentum of GDP increases around the world.

The generally happy state of our economy is driving the rest of the world's economies to newfound gains. Our own economy continues to prosper, and our institutions continue to increase in value. While these values cannot be justified by use of historical statistics, we are in a momentum market that appears to be headed higher. One's risk can be modified in a big bull market, just as it can be modified in any market - by purchasing only those securities that are selling at value prices in any particular market.

With all the problems economically out there that we have analyzed and written about over the years, the market has discounted them all in its march to new highs. All indications are that this uptrend will continue and turn into the greatest bull market of all times.

Carpe Diem.

GOLDEN TIMES FOR GOLD

Hold your gold and buy more at these levels. Gold is cheap. Before President Roosevelt, by a mere executive order, confiscated all the gold held by the public in 1932, dollar bills of various denominations had these words written upon them: "This certifies there has been deposited in the Treasury of United States of America the exact amount of this note in gold coin to be paid to the bearer on demand."

At that time, the U.S. government had on deposit enough gold (and silver) to redeem all outstanding dollars for "gold and silver species" as required by the U.S. Constitution. We have previously written that if each ounce of gold was redeemed for the dollars in our money supply at this point in history, each ounce of gold would have to be revalued to almost $50,000.

This is what the government has done to our money. With gold selling at $660 an ounce, and with paper money out there to cover each ounce equal to $50,000, gold must go up in value.

George Rauch, a Longboat Key resident, is chief executive officer of Bradenton-based General Propeller and a former Wall Street investment banker.