Paul Ferraresi

For many months I have written about the over valuation of the stock market and the need to hedge one’s portfolio.

There are street savvy experts and Nobel Prize winning financial gurus that I follow. Over the years they have hit the market moves consistently on countless times.

Here are some of their excerpts to make my point.

• According to midyear annual data the median U.S. stock price in 2014 stood at a post World War II high of over 20 times earnings.

• The median price-to-cash-flow ratio, at 15, was also at a postwar high. In fact, the median P/E alone had jumped from around 12, at the depth of the Great Recession in 2009, to the aforementioned 20-plus.

• After similar previous highs of the median P/E in 1962 and 1969- the periods most comparable to today’s broad-based high valuations- a nasty selloffs of 27% and 35%, respectively, occurred.

• They are all concerned over the declining participation of individual stocks and sectors in the market’s snapback rallies in the past six months. This phenomenon can be seen in declines in the advance/decline figures and the number of stocks hitting new highs and trading above their 200-day moving averages.

• Complacency has replaced fear.

• A growing boom in “nonpurpose loans” that Wall Street is proffering to wealthy clients who have large portfolios of stocks and bonds that serve as collateral for the borrowing. The only proviso on the cheap financing is that the money not be used for securities purchases. The money is going into illiquid assets like second homes, condos for mistresses, yachts, and insensate consumption. In a market selloff, the liquidation of securities collateralizing these loans could add tinder to any market conflagration.

• The psychological setup for a market bust has been present for more than a year. Investor liquidity continues to dry up, and sentiment indicators show increasing stock-investor derring-do.

• A resurgent U.S. economy will not afford much protection for stocks. Take the much-heralded initial jobless claim numbers that hit a 14-year low last fall. That number also hit lows in June 1987, March 2000, and June 2007, which were all close to major market highs.

• Coincidence or correlation? Who knows. But we’ll most likely find out soon.

Look at your Investment Policy statement and review how much of a loss you are willing to take in your portfolio. Then, hedge your position so you do not lose any more than that amount.

Foreign Direct Investment (FDI) is a huge source of capital that provides for business growth and huge job growth.

In 2009 that number dropped as the financial crises took hold world wide. It slowly came back up until the huge drop from 2012 through 2013.

Why the big back off:
• Heated presidential election and uncertainty
• Drag out budget battles (uncertainty)
• Debt ceiling fights (uncertainty)
• Government shutdown (uncertainty)
[Our politics frighten foreign investors]
• EPA tougher air quality regulation (bad for business)
• Dodd Frank rules (killer for business)

Less foreign investment means fewer plants built resulting in less new jobs and continued “hand-outs.”

Seeing this, the Obama Administrative has set up. “Select USA.” Another government agency. The purpose is to help foreign investors navigate the Byzantine Federal and State Red Tape. Why not just remove the useless regulations. Funny in New Zealand, you can apply to set up a new business today and the next day you are open. Here it takes 9 months to 2 years. Duh!

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There are many reasons for caution as the stock market marches higher.

• Corporate insiders are selling at a feverish pace.

• The Fed continues to hint that tapering will begin soon (this will take the liquidity out of the bubble balloon).

• Margin debt at record levels

• Investor complacency as “VIX” hits 10 year low.

• Huge inflows of small investor monies from cash to equities (after sitting on the sidelines for 5 years. Small investors always buy high and sell low).

• Professional investors are raising cash.

• Warnings from top money managers of bubble like conditions.

• Every sector in the market is up substantially versus 1999 when it was just tech stocks.

• Small cap stocks are super expensive.

The Fed will keep interest rates low which will move the market to continue upward for a while. The higher it goes the greater the drop. Check with your advisor and review your Investment Policy and the standard deviation you are willing to accept. Then, get your strategy in place.

The history of the stock market shows over 141 years of equity performance, and that there is a straight-forward cyclical pattern that emerges: Periods of worse-than-average returns followed by periods of better-than-average returns and vice versa. The most recent five years have definitely been in the worse-than-average period. Plus, since 2000 the market has been flat. (Keep in mind from 1980 to 2000 the markets produced way above average returns. Therefore, one knew that from 2000 to current would have to be below average to regress to the mean).

Jeremy Siegel, Wharton School professor and author of “Stocks for the Long-Term,” also notes the standard cyclical movement of stocks. He concludes with the following:

Earnings growth rates determine stock market performance. In 2011, earnings per share of the DOW grew at 12%. Most estimates are for earnings to grow at 9% each year for the next two years. To get to a 15,000 DOW in two years would require an 8% annual earnings increase and the Price Earnings (PE) ratio moving from 13.1 to a modest 13.6. Reaching this level is very feasible since the long-term average return of the stock market has been about 12% per year. Thus, an 8% per year increase, is right in line.
Others estimate that DOW 17,000 in two years is not out of sight. In spite of all the Anti-Business, heavy regulated prose from the present administration, the stock market has roared back over the past three years.

Let us look at the pattern: From 1982 to 2000 the stock market soared at above average returns. From 2000 to 2011 the market has been flat. So, it is rational to assume that returns will resume in an upward pattern. If all your friends, coworkers and contacts are convinced the market is dead…that is a good contrarian sign. Remember…the crowd rushed into the market full force at the top in 2000. This same group rushed out of the market when it hit bottom in 2009. Remember the success motto on Wall Street…buy low – sell high… which is the opposite of what the crowd did recently, and at EVERY market top and bottom.

The fees associated with 401k investments have been hidden as have the entities claiming those fees. New Labor Department regulations will break down and make transparent those fees for the employers and workers. Additionally, there is a requirement that benchmark performance be provided so you can judge how your investment is doing relative to an index.

The rules are in place and the implementation has been delayed from the original date in July 2011.

Here is a really “sick” survey. The AARP found that 70% of 401k investors think they do not pay any fees for their 401k plan. When people state the same to me I ask…Tell me how long would you work at your job if you were not getting paid your salary? For the 70% that claim there are no fees, you are saying to me… all the people in your company, the custodian as well as the advisors who prepare all the reports, do the investing and those who handle the phones do it for free? Duh! What a rude awakening people will get when these 401k fee reports come out. You see, the fees are taken from your account returns. If there are no returns then your account loses value as they extract the fees from your account value.

There are a few major fees associated with 401k plans: One for managing the specific investment (usually mutual funds, annuities, or ETFs). Second are fees for record keeping, plan administration; e.g., transferring money, providing education, customer service, and keeping the plan compliant with the government.

There is a third fee for actions taken by you, such as, a loan, hardship withdrawal or actions related to a divorce. So even if you do not have actions such as above, you will pay a portion of the fee for the action your coworker took. Ah yes, socialism at its greatest!

Oh, one other thing: Remember, the mutual funds you invest in may have an up-front load fee (commission), and all of them charge a management fee of 1-4% per year.

Those of you in small firms — fewer than 100 employees — well, the boss (owner) is paying for a lot of those annual fees. In my experience, many owners are getting fed up, closing out the 401k plans, and offering employees much safer non-qualified plans instead.

In 2013 those 401k’s that have ETFs in them will be under the same requirements to disclose all the fees.

Why not consider better alternatives to IRAs and 401k’s that allow your money to grow tax free. You can withdraw it at any time without any tax or penalty, and when you die, it transfers the income tax free.