Doug Short, Vice President of Research at AdvisorPerspectives, discusses the state of the market and looks ahead to 2013.
John Nyaradi: Hi, I’m John Nyaradi, Publisher of Wall Street Sector Selector, and today our special guest is Doug Short, Director of Research at AdvisorPerspectives.com. Doug, welcome to Wall Street Sector Selector.
Doug Short: Glad to be here.
John Nyaradi: Doug, it’s great talking with you. You’re one of my favorites in the internet world. Doug is a former full professor at North Carolina State and he’s now Director of Research at AdvisorPerspectives.com, a widely read and well known financial website.
Doug, one of the things you talk about regularly is regression to trend as a way to get perspective on long term market performance. Where’s the S&P (NYSEARCA:SPY) now relative to this long term trend and where is it going next?
Doug Short: Well, that’s a good question. One of the things I think is true about economic cycles is they tend to be a lot longer than we normally expect and we don’t really have very many of them to look back on to make any kind of firm conclusions about where we are in the cycle, where we’re headed next, how long it’s going to last.
I like to use the data set that Robert Shiller, Yale professor and author of Irrational Exuberance, has made popular and that’s the S&P Composite. (NYSEARCA:SPY)
The updated series goes back to 1871 and when you look at it, we see some things that are pretty obvious. You see The Roaring 20s followed by the big peak in 1929 and the incredibly volatile downtrend that lasted a couple of decades through The Great Depression. Then we see World War II and a real surge from 1949 through the mid 1960s.
But then we see another huge cyclical downtrend that ended in approximately the summer of 1982 and then from ’82 to 2000, an amazing boom.
If you look at the entire data series, we’re still above trend. My last calculation based on the data of from last month shows that we’re roughly 44% above historical trend.
John Nyaradi: There’s a lot of discussion about whether this is a bear or bull market. What is it?
Doug Short: If you believe that the low that we had in March, 2009,. was the beginning of a secular bull market, then there’s your answer. Historically speaking, however, the market has usually fallen considerably further below that regression line I spoke of earlier.
So I remain skeptical. I think it’s very possible that we could see the market suffer an additional significant decline or two before we’ve got this out of our system, and by that I mean the end of the deleveraging cycle that we’re going through.
We also have some demographic issues coming up. Baby boomers are retiring at the rate of about 10,000 a day. It’s a process that’s going to continue for many more years. So as a result, what are we going to see? Increasing pressure on social benefits. Households drawing down on investment assets. So this is going to put some additional pressures on the overall economic trends and they’ll be quite different from what we had from the early 80’s, the Reagan era of tax cuts, and the boom years that we had in the 90’s.
So I think we need to be patient, tactical in our decisions about how we invest and guarded in our expectations.
John Nyaradi: One of the real interesting things you do that you don’t see too often is the Q-Ratio. What’s that about?
Doug Short: Q ratio is the real price of the market divided by the 10 year average of real earnings and this is data that we can go back into the latter part of the 19th century and reconstruct. The interesting thing to me is when I look at these various indicators, regression to trend, the cyclical P/E ratio and the Q ratio, they all seem to be saying approximately the same thing, that right now the market’s overvalued.
John Nyaradi: How about the ECRI and their recession predictions. Could you talk about that a little bit about what you’re seeing there?
Doug Short: ECRI made their recession call to their private subscribers, I believe, on September 21st of last year. They made the announcement to the general public about 9 or 10 days later. Their spokesperson, Lakshman Achuthan, says that we already entered a recession and his company is guessing that it started in July of this year.
I, on the other hand, like to look at the same indicators that the MBER looks at for recessions, and I call them the big four indicators.