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Market Wrap Up November 11/04

 

by Martin Goldberg

Is there anything new Under the Sun on Wall Street?
(Probably Not)

The latest rally has been impressive and the heavy trading volumes suggest that it may continue in the days even a couple of weeks ahead, but is it time to rethink whether this is a new bull market? If you wait, are you missing a once-in-a-lifetime chance to hop on a New Bull Market while it’s still early and get rich quick? Is it finally time to listen to the “everyone” who has been right for about two years? Is the next major move up? My opinion in a few words is that this is not a bull market, because: 1. Technical Charts – There is a preponderance of broadening patterns in sector, market, and company charts, which I have discussed in an article last April. The extent of the broadening patterns in the broad stock market has even broadened recently. 2. Fundamental Valuations – The stock market is arguably more expensive now than it was at the 1929 peak, which was also about the time that a president with the reputation for being “good for business” took the oath of office. While this tradable rally is likely to continue by most accounts, this is not a Bull Market. Tonight, I will discuss comparative stock market valuations between those of 1929 and the present, which suggest that our current stock market is expensive by historic standards and has valuation metrics similar to pre-crash 1929.

Below is a Table that summarizes the Dow Jones Industrials (DJIA) valuation parameters in 1928, and 1929. Data are from the “Selected Stocks Stock Picture” chart service dated October 1955 by M.C. Horsey & Company, Publishers purchased from L & S Trading. There are data on 20 of the 30 stocks from the DJIA of 1929 found in the “Selected Stocks” document, which are summarized in Table 1 below

Table 1 - Dow Jones Industrials in “Selected Stocks” M.C. Horsey October 1955

Table 1 Notes:
(*) Not included in Average
(1) Stock peaked in 1928. The 1928 Peak is listed and used to calculate the 1929 price peak dividend yield.
(2) Stock peaked in 1926. The 1926 Peak is listed and used to calculate the 1929 price peak dividend yield.
(3) Stock peaked in 1930. The 1930 Peak is listed and used to calculate the 1929 price peak dividend yield.
(4) Actual 1929 price peak dividend yield is higher because three listed stocks did not peak in 1929.

Business was booming in 1928 and early 1929 as Wall Street saw only blue skies ahead. In 1928, those 20 DJIA companies achieved average earnings per share (EPS) of $2.94. Of that $2.94 these companies paid 48% of it back to their shareholders in the form of dividends. In January of 1929, investors were willing to pay 18-times trailing earnings for the average company listed, and received a dividend yield of 3.4%. By the parabolic stock market peak that occurred in October 1929, investors were willing to accept a dividend payout of more than 2.4%. So how do these valuations compare to those of today? Similar statistics pertaining to today’s Dow Jones Industrial Average are summarized below in Table 2.

Table 2 - Dow Jones Industrials, November 2004 (Source: Yahoo Finance)

Name	Price (5 Nov. 2004)	EPS (Trailing)	Div/Shr	EPS Est.	P/E (Actual)	PE Estimate 2005	Div. Yield
ALCOA INC	33.34	1.58	0.60	1.63	21.01	13.44	1.81
AMER INTL GROUP	61.05	4.15	0.30	4.39	14.72	11.72	0.49
AMER EXPRESS CO	55.12	2.63	0.48	2.73	20.89	17.84	0.87
BOEING CO	51.15	3.45	0.80	2.51	14.66	19.76	1.58
CITIGROUP	46.13	3.15	1.60	4.04	14.63	10.47	3.47
CATERPILLAR INC	87.17	5.17	1.64	5.72	16.61	12.32	1.91
DU PONT CO	44.18	2.12	1.40	2.33	20.66	16.1	3.2
WALT DISNEY CO	26.43	1.08	0.21	1.06	24.37	21.93	0.80
GENERAL ELEC CO	35.19	1.53	0.8	1.58	22.93	19.71	2.28
GENERAL MOTORS	39.8	5.29	2.00	6.34	7.47	7.55	5.06
HOME DEPOT INC	42.29	2.10	0.34	2.22	19.97	16.64	0.81
HONEYWELL INTL	35.95	1.66	0.75	1.68	21.43	17.61	2.11
HEWLETT-PACKARD	19.69	1.06	0.32	1.30	18.42	13.2	1.64
INTL BUS MACHINE	93.28	4.70	0.72	5.01	19.66	16.68	0.78
INTEL CORP	23.36	1.14	0.16	1.11	20.07	20.61	0.70
JOHNSON&JOHNSON	59.18	3.05	1.14	3.07	19.42	17.73	1.93
JPMORGAN CHASE	39.35	1.95	1.36	3.04	20.33	11.76	3.43
COCA-COLA CO	41.4	1.88	1.00	1.99	22.00	19.88	2.42
MCDONALDS CORP	30.06	1.58	0.55	1.91	18.75	14.96	1.86
3M COMPANY	81.4	3.61	1.44	3.75	21.63	18.77	1.84
ALTRIA GROUP	54.06	4.64	2.92	4.71	11.69	10.57	5.38
MERCK & CO	26.21	2.73	1.52	2.60	9.90	10.43	5.63
MICROSOFT CP	29.31	0.78	0.32	1.25	37.18	20.86	1.10
PFIZER INC	28.79	1.19	0.68	2.13	24.42	12.47	2.34
PROCTER &GAMBLE	53.52	2.42	1.00	2.59	21.98	18.53	1.88
SBC COMMS	26.25	1.60	1.25	1.48	16.33	20.57	4.79
UNITED TECH CP	97.25	5.39	1.40	5.50	17.80	15.68	1.46
VERIZON COMMS	41.01	1.19	1.54	2.50	34.52	15.5	3.75
WAL-MART STORES	56.47	2.21	0.52	2.39	25.46	20.68	0.92
EXXON MOBIL	50.39	3.6	1.08	3.59	13.94	15.07	2.00
Averages (arithmetic)	46.96	2.62	0.99	2.87	20	16	2.3

In January of 1929, investors paid 18 times trailing earnings for Dow Jones Industrial stocks while today they are willing to pay 20-times earnings. Whereas 48% of the earnings were paid out to shareholders in dividends then, today DJIA companies pay out 38% of their earnings in dividends. Just before the 1929 crash, the 20 DJIA companies yielded more than 2.5% in dividends, yet today the DJIA yields even less (2.3%). (This excludes Microsoft’s special 2004 dividend.) In 1929, with a major stock market crash looming, average dividend payout per share in the 20 DJIA companies increased by 18% versus 4% this year. These comparatively lower dividends today occur about 2 years after the government instituted reduced tax rates for dividends. While the common knowledge on Wall Street is that dividends are still “not in style” as they were in the past, facts suggest that the only reason for today’s relatively low dividend yields is because stocks are overvalued in the stock market. With respect to dividends, there isn’t anything new under the sun.

Conventional wisdom suggests that today’s “low” interest rates justify higher stock market valuations. So you would think that interest rates were higher around 1929 compared to now. So what was the rate of the 10-year Treasury note in 1929 compared to today’s rates? The rate was lower then than now – 3.3% in 1929 compared to 4.2% today (rates appear to be rising concurrent with four straight Federal Reserve interest rates hikes and at least another one “in the bag”). If all other factors were equal, stocks should be valued lower today versus 1929 on the basis of the 10-year Treasury note interest rate.

Is the stock market forecasting boom times ahead not seen in the rear view mirror of past earnings or forward estimating Wall Street analysts? This cannot be known for sure, but you must consider that the all time high 12-month per share earnings in September 2004, are over 11% higher than the earnings in any previous 12-month period ever! As listed in Table 3, below, Wall Street analysts see the DJIA increasing its 2004 EPS by an average of 14% in 2005. Does it seem plausible that the large and somewhat stable DJIA companies are poised to grow earnings by 14% above than the current all time high? Such lofty expectations were probably the order of the day in early 1929 as well. In the most recent stock market crash that began in late 1999 and early 2000, Wall Street analysts were expecting earnings growth of more than 13% above the all-time-high earnings, and we all know how that prediction turned out. Table 3 below outlines the current Wall Street analyst predictions for the DJIA.

Table 3 - 2005 Analyst Estimates For DJIA (Source: Yahoo Finance)

Name	2004 EPS	2005 EPS Estimate	Estimated Growth (%)	Positive Estimated EPS Growth	EPS Estimated Shrinkage
ALCOA INC	1.58	1.63	3.2	3.2
AMER EXPRESS CO	2.63	2.73	3.8	3.8
AMER INTL GROUP	4.15	4.39	5.8	5.8
BOEING CO	3.45	2.51	-27.2		-27.2
CITIGROUP	3.15	4.04	28.3	28.3
CATERPILLAR INC	5.17	5.72	10.6	10.6
DU PONT CO	2.12	2.33	9.9	9.9
WALT DISNEY CO	1.08	1.06	-1.9		-1.9
GENERAL ELEC CO	1.53	1.58	3.3	3.3
GENERAL MOTORS	5.29	6.34	19.8	19.8
HOME DEPOT INC	2.1	2.22	5.7	5.7
HONEYWELL INTL	1.66	1.68	1.2	1.2
HEWLETT-PACKARD	1.06	1.3	22.6	22.6
INTL BUS MACHINE	4.7	5.01	6.6	6.6
INTEL CORP	1.14	1.11	-2.6		-2.6
JOHNSON&JOHNSON	3.05	3.07	0.7	0.7
JPMORGAN CHASE	1.95	3.04	55.9	55.9
COCA-COLA CO	1.88	1.99	5.9	5.9
MCDONALDS CORP	1.58	1.91	20.9	20.9
3M COMPANY	3.61	3.75	3.9	3.9
ALTRIA GROUP	4.64	4.71	1.5	1.5
MERCK & CO	2.73	2.6	-4.8		-4.8
MICROSOFT CP	0.78	1.25	60.3	60.3
PFIZER INC	1.19	2.13	79.0	79.0
PROCTER &GAMBLE	2.42	2.59	7.0	7.0
SBC COMMS	1.6	1.48	-7.5		-7.5
UNITED TECH CP	5.39	5.5	2.0	2.0
VERIZON COMMS	1.19	2.5	110.1	110.1
WAL-MART STORES	2.21	2.39	8.1	8.1
EXXON MOBIL	3.6	3.59	-0.3		-0.3
Averages (arithmetic)	2.62	2.87	14.4	19.8	-7.4
No. Cos.				24	6

Included with the super sized earnings growers predicted by Wall Street in 2005 are financial companies, Citigroup (28% growth), J.P. Morgan (56%), and General Motors (20%). Other predicted super sized growers include Verizon (110%), Microsoft (60%), Pfizer, and McDonalds (21%). Wall Street predicts earnings shrinkage in Boeing, Disney, Merck, SBC Communications, and Exxon Mobil. The predicted earnings growth rate for those 24 companies expecting positive earnings growth is about 20%, and the predicted shrinkage for the 6 companies not expecting growth is about 6%.

How do the growth rates predicted for today compare to those actually achieved around 1929? Table 4 below summarizes the DJIA earnings in 1928 through 1930.

Table 4 - DJIA Growth Rates 1929

Company	1928 EPS (actual)	1929 EPS (actual)	1930 EPS(actual)	1929 Growth (%)	1929 Positive Earnings Growth	Negative (Earnings Shrinkage)
Allied Chemical	2.78	3.15	2.44	13.3	13
Allied Can	1.72	2.01	2.02	16.9	17
American Smelting	3.44	4.2	1.55	22.1	22
American Sugar	7.60	7.77	5.58	2.2	2
American Tobacco	5.58	5.76	8.56	3.2	3
Atlantic Refining	2.57	2.07	0.34	-19.5		-19
Chrysler	3.40	2.47	0.03	-27.4		-27
General Electric	0.60	0.75	0.73	25.0	25
General Motors	3.02	2.72	1.66	-9.9		-10
General Railway Signal	5.25	8.25	7.07	57.1	57
International Harvester	1.80	2.37	1.52	31.7	32
International Nickel	1.47	0.67	1.28	-54.4		-54
Mack Trucks	3.91	4.39	0.67	-70.8	12
Paramount Publix	1.00	1.45	0.5	45.0	45
Radio Corporation	3.33	0.33	0.02	-90.1		-90
Standard Oil (J.J.)	2.22	2.38	0.83	7.20	7
Union Carbide	1.24	1.31	1.04	5.60	6
U.S. Steel	2.08	3.53	1.52	69.7	70
Westinghouse Electric	2.24	2.58	1.25	15.20	15
Woolworth	3.63	3.66	3.56	0.80	0.8
Averages	2.94	3.09	2.10	-3.2	23	-34
Number Cos.					15	5

The stock market peaked in October of 1929, yet in total, earnings were largely unchanged in 1929 versus 1928. Conditions weren’t all that bad in 1929 for most of the DJIA as 15 of 20 companies with positive earnings growth achieved an average of 23% growth. Yet those 5 companies with earnings shrinkage averaged minus 34% growth. Although I don’t have the supporting quarterly data, I suspect that earnings were generally excellent going into October 1929, and started to swoon during the 4th quarter. Earnings shortfalls probably occurred practically concurrent with the stock market crash. By the end of 1930, earnings dropped by 32% while the stock market crash was on in full force. In 1929 things looked rosy until practically the moment that they turned bad. There is every reason to believe that with valuations higher, dividend yields lower than in 1929 and interest rates going up, similar stock market behavior may happen once again. There isn’t anything new under the sun.

Technical View – Broadening Patterns 

I want to emphasize that the fundamental case presented above is more months-to-a-year-based, than a prediction of what will happen tomorrow or the day after tomorrow. In January 1929, the DJIA opened the year at about 260 and gained an additional 50% before topping in October at 388.10. There may be some clue as to timing the top from the discussion of broadening patterns in Technical Analysis of Stock Trends, 8^th edition (page 151) that may suggest that from a timing perspective, we are near the top:

“This particular form (broadening) appeared at the 1929 tops of many of the active and popular stocks that day, but with less frequency at the Bull Market highs since 1929…”

Here are some present day examples of broadening patterns – including two index traded funds (mid-caps, and S&P 500 equal weight) which, in addition illustrating broadening patterns, suggest that index traded funds are today’s version of “active and popular stocks of the day”. Also included is the S&P retail index.

Summary and Conclusion

In summary, there isn’t anything new under the sun because human nature never changes. In the continuing stock market game in a free market system, stock prices are just a mechanism where by the informed few take wealth from the less informed public. This will never change. As I write this, the stock market is having an impressive and almost vertical rally that is drawing in more formerly skeptical public participants. This rally is happening less than 4-years since the bursting of the Internet bubble, and less than 2-years after the rally that “everyone” predicted would occur concurrent with the beginning of the US military action in Iraq. Also, we’re now in the midst of a rally that “everyone” said would occur if the incumbent were elected president. The rally happened after “everyone” who said that the market would remain afloat until after the election was proven right.

This weekend I’ve spotted several formerly bearish pros that appear to have abandoned their bearish outlooks for the stock market based on technical reasons or fundamental anecdotal observations. It wouldn’t be appropriate to hang a label on such people as “flip-floppers” because in a complex world where conditions sometimes change, modifying one’s position is often appropriate and necessary. There is no shame in an informed change of viewpoint because only the simple-minded maintain stubborn views regardless of the changing and complex conditions. Such inflexibility can render their stubborn attitudes disastrous. So is it time to reevaluate fundamental views of the stock market and go long for more than just a trade, while taking the position that “everyone” is taking?

In spite of the opinion of apparently “everyone” that the stock market is going up for an extended period of time, the evidence presented above and in April suggests a possible tradable rally at best in the near term, and a replay of 1929 is possible if not likely in the longer term. With eyes on the months-to-year timeframe, I’ll gladly and with conviction, play the part of the last contrarian standing because there isn’t anything new under the sun.

How is this Possible?

With large companies posting excellent earnings this year, it is notable that shareholder equity or “book value” of the S&P 500 has actually decreased by over 6% the last 12-months. When the official purpose of earnings is to either pay back the shareholders in dividends or build equity, it is notable when an index of 500-companies loses a significant amount of its shareholder equity in the same year that they post record earnings. While in the short term in a speculative market book value doesn’t mean anything, the loss of it seems a bit fishy to me. I doubt if such items that eat away at shareholder equity as write-offs, share buy-back/stock option awards, and alike were the order of the day in 1929.

Today’s Market

With bonds not trading because of Veterans Day, the stock market made a flagpole rally today led by Nasdaq and speculative names. Volumes were nothing special, and as I write this Kudlow and Kramer are shouting for me to BUY! Watching this is my self-imposed punishment for missing this rally. If I miss another one, then I promise to force myself to sit in front of the TV and watch a week’s worth of their taped shows with eye-lid holders to keep my eyes wide open. It won’t happen again! Google led the charge up. As I scan the charts I’m seeing a lot of the speculative favorites leading. Cheesecake Factory traded near a 52-week high today and now trades at a P/E of 41. It’s not a factory; it’s a restaurant. Since last week, we have seen the S&P 500 to 10-year note price relationship break down. That’s too bad because it was the basis of my article last week. But in the long-term interest increases are generally not good for stocks. In the short term, “these baby’s are goin' up!” Without a logical basis for setting stop losses, there is no basis for going short. Without a healthy pull back, there is not a strong technical basis to chase stocks except for panic. Although the picture for retailers is mixed, it seems that they are going up indiscriminately. Mediocre earnings have not derailed retailers such as Zale and Dillards. Dreadful earnings have not even hurt Pep Boys all that much. I suppose the market is discounting that the stock market will do well and consumers will feel rich as a result and buy a lot of stuff during the holiday season. Can this stock market induced consumer-based leverage go on forever? On days such as this it seems as though it can, and it must have felt the same way in the summer of 1929.

Dell reported good earnings and is being bid up after hours in spite of a P/E not justified by its growth rate. For all of the money Dell Computer has made over the years the amount of shareholder equity they accumulated over the years has been about $2.50 per share. What’s the dividend yield for this company? 0.00%

The Canadian energy companies are in a technically healthy bull market and many of them have pulled back to their 50-day moving averages. Here is a 2-year chart of oil with trendline that puts the recent drop in oil prices in perspective. With oil dropping, all the spin is based on “good news” with not a word about “the speculators”. With everyone watching the price of oil as they were in the summer, there is a good reason to believe that the upward trendline will be broken only briefly. A drop of oil below the trendline soon will be simulative to the consumer during the winter holiday season and stimulate that portion of the economy. 

Here is a 2-year chart of Talisman Energy (TLM) illustrating that it could have been purchased with regularity, just below its 50-day moving average.

Have a great evening!

Martin Goldberg

Copyright © 2004 All rights reserved, as published on www.financialsense.com

Martin F. Goldberg, MS, P.E.
Market Analyst
email mdelmgoldberg@comcast.net

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