Mark J. Lundeen
01 July 2011
The week ended with the Dow Jones up 4.48%, and gold down 0.92%. On CNBC, as usual, much was made of the Dow’s performance, with the term of “bull market” frequently used to describe this week’s gain in the Dow. Gold, on the other hand, is portrayed as “clearly in a bear market”, with no shortage of “financial experts” pessimistic over the future prospects for gold and silver. It would seem that the risk of higher-interest rates is placing tremendous downward pressure on the precious metals. As you will see further down in my article, higher-interest rates are actually good for gold and silver! Where do the big networks find these “experts?”
But one issue never discussed in the media, is the inflationary consequences caused forty years ago when the US abandoned the fixed price of gold at $35 an ounce which had been pegged there since the Bretton Woods Agreements in 1944, and ended the redemption of US dollars for gold by foreign governments at any price. Bull market in stocks, bear market in gold? Is that what you see below? Seeing gold would outperform stocks forty years after it was kicked out of the world’s monetary system is something to be expected!
Since the world was taken off the gold standard, gold has in no uncertain terms outperformed the Dow Jones. This chart’s data was personally compiled by the author from old issues of Barron’s, week by week, so you can trust what you’re seeing above. It’s scandalous how CNBC passes on mostly poor quality marketing material from Wall-Street bucket shops as investment advice to retail investors.
Well, if gold and silver are the only shows in town worth buying a ticket to, why should we follow the Dow Jones? I spend a lot of time with the Dow Jones as the Dow is always in the background of whatever else is happening in the financial or commodity markets. Ask the man (or woman) on the street what is happening in the much larger and more important bond market; chances are they don’t know or even care. But when people watch one of the legacy-networks’ nightly news program, they believes it was a better day when the Dow Jones (just 30 blue-chip stocks) closed up 100 points, than down. The “policy makers” understand the importance of the Dow Jones on public opinion, and for that reason they are currently working very hard keeping the Dow above its 12,000 line. A little excitement in the Dow Jones, like this week’s 4.48% gain, goes a long way in shaping public opinion on the economy.
Let’s look at the chart below, the Dow Jones has been trading in a fixed range since 1996 (blue plot, red square). Fifteen years of doing nothing for investors. However, since 2000, the Dow Jones is actually a story of investors paying capital-gains taxes on inflationary losses in the stock market. Why is that? Because since 1913, when Congress created the Federal Reserve, “monetary policy” has greatly increased the number of US dollars in circulation (CinC). There are now 8 dollars in circulation for each dollar in circulation in 1980. On an inflation adjusted basis (red plot below), blue-chip stocks when priced in constant 1980 dollars, have delivered significant negative returns for the past twelve years. The Dow Jones is 38% below its inflation adjusted highs of April 1999. Since 1980, blue-chip stocks have provided only a 78% pre-tax return in inflation-adjusted capital gains, and that would be substantially lower after paying capital gain taxes on the nominal gains of ~900%.
The Greatest bull market in the 20th century has only been an inflationary illusion.
Returning to the nominal dollar blue-plot above, will the Dow Jones break decisively upwards out of its box? Don’t hold your breath! My expectations are, that we will see the Dow break decisively below its lows of March 2009, as the Federal Reserve relentlessly expands CinC towards infinity. Before this bear market is over, I expect the Dow’s huge head and shoulders formation will be completed in a particularly nasty manner for the bulls.
How far could the Dow Jones fall? Well, stock-market investors have been in a bullish mood for decades, and bull’s don’t give a sweet-rat’s petutti about dividend yields. They never have, and they never will. But historically, dividend considerations eventually become paramount in bear markets, after the investing public accepts the new reality that capital gains are only distant memories and wishful thinking.
Let’s take a look at the Dow’s dividend yield from 1925 to 2011. Bull markets in the chart below can be identified by the Dow’s dividend yield falling down to the 3% line. In Bear Markets we see the Dow’s dividend yield rise from a 3% yield to above the Dow’s 6% line. From 1925 to 1987 (62 years), this relationship held fast. But then Doctor Greenspan became Fed Chairman in August 1987, and nothing has been the same since.
The bubble Doctor Greenspan inflated into the stock market has yet to deflate. I can say this with certainty, by simply pointing out the fact that since 1993, the Dow has been yielding less than 3%. What about that little 4.7% spike we see in the far right of the chart above? Oh, you must be referring to the Dow’s March 2009 bottom, also known as the #2 Dow Jones Bear Market bottom since 1885!
The astonishing thing is that the Dow’s yield increased to only 4.7% in March of 2009, resulting in the second deepest bear market bottom since 1885! This is not only an indication of how grossly inflated stock market values were in January 2000, when it yielded a miniscule 1.30%, but how painful it will be for shareholder values when the Dow Jones once again sees a dividend yield above 6%; which someday it will. Currently, the Dow is paying $300 a year in dividend payouts, yielding 2.39%. Assuming the Dow Jones can maintain its current dividend payout, the table below tells us what happens to the Dow when its dividend yield reaches 6%: the Dow Jones declines to 5000! That would be a 65% decline in the Dow Jones from its highs of October 2007.
Valuating The DJIA with Dividend Payouts & Yields
Range of Possible DJIA Dividend Yields
Div P/O2.0%4.0%6.0%8.0%10.0%12.0%$30015000 7500 50003750 3000 2500 $25012500 6250 4167 3125 2500 2083 $20010000 5000 33332500 2000 1667 $1507500 3750 2500 18751500 1250 $1005000 2500 1667 1250 1000 833 $502500 1250 833 625 500 417 Historically, Dividend Yields Have Always Risen in Bear Markets.
Sometimes Dividend Payouts Fall.
Graphic by Mark J Lundeen
Most people alive today only understand the stock market from the perspective of a bull. So pricing the Dow in terms of yields is alien to them. But the relationship between valuation, payout and yield is simple, mathematical, and non-negotiable. It applies in bull markets too, but bulls are rather stupid animals. Other than how many dollars they are up or down this day or week, the fundamental mathematics of the stock market is beyond them. I remember watching CNBC in January 2000, as the Dow topped out. Not a single stupid bull commentated that the Dow was yielding only 1.30%, making the stock market in January 2000 the most overpriced in the history of American finance. The provided link shows that some bulls in 1999 believed 36,000 for the Dow was reasonable!
But Mr Bear is a very clever animal, one who takes great delight in the simple mathematics (complex for bulls) seen in the table above. He’s a real bastard, too. For the simple joy of seeing the bulls flee like rats from the stock market, he’s not above driving the yield for the Dow Jones up past 8% with a 50% reduction in the payout. Such a move is well within the historical range of possibilities. Looking at the table above, this would drive the Dow down to 1875 for a bear market low of -87% from the Dow’s October 2007 high. This would rival the -89% drop the Dow made in 1929-1932 for the all time bear market bottom.
How likely is this? It is unavoidable in my opinion! Dividend yields will increase greatly as bond yields and interest rates increase to double digits. And rising interest rates will crush the public’s personal finances and corporate profits, making cuts in dividend payments a top priority by management.
How likely are interest rates to rise? Very likely! During the 30 years from 1971 to 2001, the trends in the price of gold (blue plot, left scale) and the US long bond yield (red plot, right scale) were closely correlated, with the price of gold frequently a leading indicator of future trends in bond yields. With rising consumer prices being the great levitator of bond yields – and gold, the chart below is a record of wealth fleeing fixed income, into gold from 1971 to 1980.
This fact is not widely recognized by “investment experts” today, but historically, the price of gold feeds on the flow of flight capital from fixed income as bond yields rise with consumer prices. The reverse is also true. Note that ever since the price of gold was released from its Bretton Wood’s $35 to one ounce of gold fix, the price of gold has suffered when * declining * bond yields caused investment flows to reverse, as is clearly evident below.
But this was only true until August 2001, when bond yields continued declining in the face of rising gold prices. Since 2001, the bull market in financial assets has been really creepy! Yes, “creepy” is precisely the correct word to describe what the Dow Jones and the US Treasury bond market have been doing in the face of rising gold prices. There is something really wrong with this picture, but it’s not the rising price of gold!
Rising gold prices on declining bond yields, along with the Dow’s dividend yield stubbornly below 3% for the past eighteen years while the Dow has risen from 4000 to 12,000, are solid indications that the prices of financial assets are set by the needs of “policy”, rather than by supply and demand fundamentals.
What in the hell does that mean? Just look at the chart below where I’ve charted the US Treasury holdings of the Federal Reserve and the world’s central banks, in terms of percentages of the US national debt. Since 2001, central banks have been in an inflationary feeding frenzy in the US Treasury debt markets, monetizing Uncle Sam’s I-Owe-You-Nothings, into their rapidly depreciating money. So it’s really no mystery why gold has been rising for the past ten years, as bond yields continued to decline: the managers of the world’s currencies are committing monetary suicide.
Obviously, the price of gold for the past ten years is not feeding on flight capital from deflating bond prices. So where is the money coming from that is driving gold higher? From the Fed’s “monetary policy”; as stated by Doctor Bernanke himself.
“By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services.”
– Ben S. Bernanke, Federal Reserve Board Governor, November 21, 2002
Helicopter Ben has been good to his word of “reducing the value of the US dollar in terms of goods and services.” People who understood the implications of Doctor Bernanke’s inflationary “policy” have been buying gold and silver for the past 10 years to protect themselves from the inevitable monetary collapse to come.
When bond yields begin to rise, trillions-of-dollars will begin fleeing the fixed-income and stock markets, and seek a store of wealth that cannot be inflated to worthlessness by central banks: gold and silver. In the past I’ve mentioned the possibility of gold rising above $30,000 an ounce. Nothing has changed my mind on this. Historically, governments have often destroyed their money by inflating it to worthlessness. This has happened many times in the history of finance, since the Roman Empire. A day is coming when gold and silver will become simply unaffordable to the impoverished masses. Gold at $1500, and silver at $33? Cheap!
But rising yields in fixed income and dividends are milestones that we have yet to pass, and the Dow Jones is only 30 large blue-chip stocks. Are there other indications that financial assets are in trouble? You betcha! Let’s take a look at the money market, where business borrows funds for their short-term money requirements.
The chart below shows the money market in dollars (blue plot, left scale), with a Bear’s Eye View (BEV) plot (red plot, right scale). The money market was very small in 1980, but had grown to just under four trillion in January 2009. It currently stands at 2.7 trillion dollars.
The money market provides us with an important insight into the health of business, since businesses use it for short term financing. And what does business use short-term money for? To finance inventory. Ideally, business wants its inventory to come into their warehouses one day, and out the next, all financed with other people’s money. This is a good arrangement, one that provides savers an income from the profitable operations of business in a thriving economy. At least it did, until Doctor Bernanke lowered short-term interest rates to zero in December 2008.
When the economy is in full gear, business is good, so the demand for 90 day money (money market funds) is high. This indicates that inventory is quickly flowing into, and out of warehouses; as fast as salesmen can get customers to sign contracts. But when the economy is doing poorly, commissioned sales personnel sit around a phone that doesn’t ring, and businesses lay off their employees. So the money market contracts as business slows, since companies don’t purchase inventory that can’t readily be sold.
Currently, the earnings for the Dow Jones are at all-time highs. But the two year, 1.3 trillion dollar collapse in the money market casts GREAT DOUBTS on the validity of the Dow’s current rise in earnings, and the Dow’s ability to sustain its current dividend payout. If the Federal government’s “regulators” were worth their salt, they’d already be investigating this divergence. But they aren’t, so be advised: the current dividend payout in the Dow Jones is vulnerable to unannounced cuts. The above chart is telling us that business is really bad in the United States. If you’ve forgotten what that portends for the Dow Jones’ valuation, go back and review my above table for yields, payouts and valuation for the Dows Jones.
The Bear’s Eye View (BEV) (red plot, right scale) earns its name in the Money Market Funds chart above! The BEV plot uses the same data from the dollar plot (blue plot, left scale) and expresses these dollars in percentages terms. Each new all-time high is reduced to a 0% (BEV Zero). All weekly values in the chart’s blue plot above that are * NOT * a new all-time high are converted into negative percentages * FROM * their last all-time high. The Bear’s Eye View plot above, compresses price data into a range of percentage spanning from 0% (new all-time high) to -100% (a total wipeout).
The money market’s BEV plot captured the severe recession of the early 1980’s, revealing a 30% contraction in the demand for short-term money that was barely noticeable on the blue dollar plot. The severity of the aftermath of Greenspan’s high-tech bubble is seen as a 21% decline in demand for 90-day money in the 2000s. However, the post credit crisis economy has produced the largest decline in demand for short-term money in the past 31 years; a 31% decline that shows no sign of abating!
This 31% contraction in demand for short-term money is also an indicator of how corrupt the political management of the economy has become. The last all-time high in Money Market Funds (Terminal Zero) occurred in January 2009, just days after President Obama was sworn in as president. Since then, quantitative easing, bailouts, direct subsidies to “green jobs”, and increases in Federal spending has sent many trillions of dollars flooding into the economies of all 50 states. I don’t know where this vast sum of money went, but the money market’s BEV Plot is telling us with certainty that these trillions in “stimulus” * DID NOTHING * for employers in the private sector. Well what else could we expect from a society where more and more power, is flowing into fewer and fewer hands, further and further away from where you and I make our living? Unions used to be local organizations funded by local union dues. But today, for the most part, the locals are controlled from their national headquarters in Washington, because these days, that’s where the money is!
One more item before I close: a look at the abnormal pattern in trading volume for the stock market since 2000. Ask yourself: what makes the stock market go up? Simple; people who were sitting on the sidelines, looking at all the EASY MONEY other people were making buying stocks, decided to come into the market too. So bull markets start with relatively few people buying stocks, but end with everyone and their grandmothers lusting after easy capital gains too. The result is an explosion in trading volume at the end of the bull market. But during bear markets, people one by one exit the market, and trading volume contracts. A good illustration of the expansion and contraction in trading volume during bull and bear markets can be seen in the NYSE’s trading volume, from 1926-42. I used a 40 week moving average to smooth the plot out.
From 1926 to the 1929 top, NYSE trading volume’s 40 week moving average exploded by 150%, then returned to 1926 levels at the market bottom in July 1932. From July 1932 to March 1937, the Dow Jones itself gained 372% during the Great Depression. But the NYSE’s trading volume tells us that those investors who survived the July 1932, -89% bottom were wary. Trading volume collapsed in April 1936, a full year before the Dow saw its 1937 top. After the 1937 top, the Dow saw some good rallies, but the trading volume required to sustain higher prices in the Dow just wasn’t there. What Wall Street did have from 1929 to 1942 were three massive bear markets (stars in the chart below). By the bottom of the 1942 bear market, the NYSE trading volume’s 40Wk M/A had contracted by 90% from its highs of 1929. By 1942, retail investors were as rare as dinosaurs on Wall Street.
But if we are to believe what we see below, “everyone and their grandmothers” in our generation are made of sterner stuff! Not only did trading volume increase going into the January 2000 top (as expected), but trading volume EXPLODED as the Dow Jones entered a 33 month, -38% bear market from January 2000 to October 2002, and then went BALLISTIC as the Dow Jones descended into the second greatest, all-time bear market bottom in March 2009. This pattern of trading volume can only be described as surreal.
Most peculiarly, since March 2009 the Dow Jones has entered into a regular CNBC “bull market” while trading volume in the stock market collapsed. Since March 2009, the fewer shares that trade on the NYSE, the higher the Dow Jones goes. It’s a scene from: Wall Street, the Theatre-of-the-Absurd!
As far as the stock market goes; I subscribe to the old fashioned idea of keeping out of it until the bear market is over! All things considered, waiting until the Dow is yielding 8% with a 50% cut in dividend payouts before you go back into the stock market is probably the best investment tip you’ll get in 2011.
So, we all have a lot of time on our hands until it’s time to start getting bullish again on stocks. So maybe you’ll have the time to read the following recent articles from Casey Research,and othershave shown that a return of over 1 million percent could have been achieved with just one single trade per decade, by identifying and riding the long term trends, * WITHOUT * using any leverage or derivatives, just 5 simple trades to turn $1000 into more than $10 million over a 40 year period. Notice that real estate was not the winning investment during any of the last four decades. The challenge we face now is to use our historical insight to determine where the safe place will be to perpetuate wealth over the coming, turbulent decade. Me, I’m thinking of physical gold and silver.
Mark J. Lundeen
01 July 2011