The Beginning of A Stock Market Crash?

Stocks are finally correcting from all-time highs and this is bound to get the bears excited. Obama’s approval rating is at all-time lows and the scent of war is in the air. We are overdue for a recession on a cyclical basis, and this just adds fuel to the fire for bears.

That being said, I suspect this rally in stocks is not being appreciated as a secular bull market for whatever reason. Perhaps it’s because of a relatively stagnant economy. Perhaps it’s global geopolitical unrest. Or perhaps it’s just the notion that record highs of anything means “overbought.” I’m not really sure, but jumping on board with stocks AFTER this correction (not crash) runs its course is probably one of the smartest things you can do as we approach the crisis window.

Alternatives and Relative Value

As an investor, you must think in terms of relative returns; you can’t make value assessments in isolation. With bond yields persistently low, the primary alternative to stocks is not attractive at all on a relative basis. This is the Jesse Livermore argument I made back in 2010 and 2011; namely that when dividend yields cross over short-term Treasure rates, it’s time to close your eyes and back up the truck.

I’ve mentioned that most of the national debt is accrued interest. Well the same holds true for stocks and dividends: most of the returns of stocks over time can be attributed to dividends, which compound over time. And persistently higher dividend yields over bond yields create increasingly distorted relative returns over time. The likely result? More pension money flipping from bonds to stocks. This is the 800 pound gorilla folks.

Stocks vs Real Estate

So stocks are attractive relative to bonds. Well if I compare stocks and real estate, it’s not even close: I’d rather be in stocks. Stocks are far more liquid and easier to manage, which means real estate theoretically needs to yield more than stocks to be attractive. Right now the earnings yield on stocks and real estate are roughly equivalent, which in itself would favor stocks. But keep in mind that we are headed into a crisis environment, which always favors liquidity.

There is a misguided notion that valuations in stocks are extreme. This is not true. If you take a look at the Shiller P/E ratio below, you’ll see what I mean. Capital has not truly concentrated in stocks yet, which means this is far from a bubble.

Screen Shot 2014-08-07 at 3.49.17 PM

Conclusion

I expect a pullback in stocks. It’s long overdue in fact. But we should see stocks outperform nearly every asset class in the years ahead. It’s not the consensus play here, but that’s why you should seriously consider it. I will probably be buying after this pullback.

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