Harry S. Dent | Tuesday, October 15, 2013 >>
Whenever I do interviews on CNBC and other financial stations I face the argument that stocks are reasonably valued right now so there’s little chance of the crash I’ve forecast for 2014 to 2015.
First, even on normal valuations measured by price-to-earnings (P/E) ratios, stocks are as highly valued as they were before the last crash in late 2007. In fact, 2013 looks almost exactly like 2007 did.
Back then GDP and job growth were good, but not great.
Stocks had seen a bull market for about five years, and nine out of ten such markets don’t last longer than that.
And there were no real negative signs in the economy. But let me tell you…
There are never bad signs in the economy near a top. How could there be? That’s when the economy looks its best.
How did Japan look in late 1989 before a two-decade downturn into early 2009?
How did the U.S. economy look in late 1929 just before the greatest stock market crash in its history?
How did the U.S. economy look in early 2000 before the tech crash stock?
You can’t look at the economy for meaningful signs of an economic slowdown or a stock market crash. You have to look at demographics that foreshadow major changes years and decades in advance. You have to look at the smart money, the insiders who see changes before the public and the media do. And you have to look at valuations on stocks and real estate that suggest a bubble or long-term peak is about to burst.
The problem is that normal P/E ratios are not the best indicator of stock overvaluation. Earnings tend to surge in the late stages of a boom or bubble and that tends to pervert valuation indicators.
Robert Shiller is the one of very few mainstream economists I like because he accurately predicted the housing bubble peak around the same time we did, and he brought the unique view that housing prices appreciate long-term only with inflation and replacement costs. Wow!
Shiller also created a new P/E ratio for seeing when stocks are under- or over-valued. The difference is that, instead of using the last year, he takes the 10-year average of earnings adjusted for inflation to iron out the cycles in earnings.
You can see his indicator in the chart below.
When you look at Shiller’s indicator, you’ll see we’re already in the stock-valuations danger zone. That’s when we see P/Es hit 24 to 25 times the average of the last 10 years. Once P/E ratios hit those levels, they fall as low as five to eight, like in 1921, 1932 and 1982. I expect the same massive breakdown between 2014 and 2019.
The 1901 peak was at 26, just above this danger zone.
The 1966 peak, near the end of the Bob Hope generation Spending Wave, peaked like we have now, at 24.
The 2007 peak was near 27, and I think we will see that again on the next stock rally between November 2013 and January 2014 before a major long-term peak.
During 1937 P/E ratios peaked around 23.
In fact, P/E ratios in most major bull markets peak between 23 and 27 on Shiller’s indicator. Those numbers represents extreme overvaluation! We’re already there and headed up.
The greatest stock bubble in U.S. history peaked in early 2000, with ratios at a whopping 44 times 10-year average earnings.
The Fed has been trying to keep that bubble from fully deleveraging ever since.
But we won’t see such overvaluation levels again. That said, what lies ahead will still hurt like crazy.
The next crash will take us even lower than the ’07 crash did, according to analysis of my Dow Megaphone pattern. I see the Dow peaking between 16,000 and 16,700 by early 2014 – at a Shiller P/E ratio of 27, similar to that of 2007 – and then crash to as low as 5,800 a few years from now. The situation may get so bad that we’ll even see a Dow of 3,300 – 3,800 in the early 2020s.
Everything I look at, from long- to intermediate- to short-term cycles suggests a major long-term top in stocks that we won’t see again for two decades or more.
So don’t look a gift horse in the mouth. Protect your stock investments and portfolio by early 2014. And consider subscribing to our Boom & Bust newsletter to get more information and recommendations.
P.S. If you missed Rodney and me in Las Vegas last week, at The Sovereign Society’s annual Total Wealth Symposium, you still have time to get your hands on a copy of the audio. Not much time though. After midnight tomorrow, these audio recordings will not be available. I suggest you secure your copy now.
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Ahead of the Curve with Adam O’Dell
Yes, the market is overvalued. And yes, we’ll continue buying stocks.