The MRI suggest the end of the current stock price decline
is several weeks away.
This post describes the current level of the DJIA from two
perspectives. First, I compare this
decline to other major price declines over the last 100+ years. If these past declines are a relevant guide, the
depth of the current decline is as severe as the
Second, the DJIA’s current valuation measures (Price/Book
and Price/Sales) compared to the period from 1993 to the present suggests that
prices need to fall further to approach low valuation levels that have been attractive
historically. From this perspective as
well, the current decline appears to be several weeks away from the end.
For the last 20+ years, the Fed has stepped in to support economic
growth by lowering interest rates when the stock market weakens and the economy
begins to falter. However, the Fed is far less likely to lower interest rates in this situation because doing
so would, at this time, encourage inflation and fighting inflation is currently the Fed’s primary objective. The MRI don’t tell us if the economy will
slip into recession. They indicate market
resilience and vulnerability. At this
time, the stock market looks very vulnerable to declines.
The Current Stock Market Decline Compared with Others
Over the Past 100+ Years
As of last Friday, we are at week 24 since prices peaked in
early January of this year. Compared to major
declines over the last 100+ years, the current decline is more severe than
prior declines, many of which went on to experience even deeper declines before
Earlier this year, I wrote that 2022 may be similar to the
DJIA decline that began in 2000. The collapse
of the Dotcom bubble beginning in 2000 most directly affected the NASDAQ stock
index, which is biased toward tech stocks. But the collapse also affected the
DJIA. The DJIA made a long slow decline
from 2000 to 2002 and then dropped again in 2003. During that period the Onyx sleeve consisting
of the ETFs XLP (consumer staples stocks), XLU (utilities stocks), and UST
(7-10-year Treasury Bonds), and SHY (1-3-year Treasury bonds) performed well.
However, over the last few months, we have seen stronger-than-expected
declines in the Onyx sleeve ETFs. Thus,
the decline that began in 2000 is not a useful guide for this decline. The broad nature of this decline suggests it could
continue for several weeks more.
Figure One below shows price performance of the DJIA for
several declines since 1929, including those beginning after prices peaked on:
1/7/2022 - the current decline
The horizontal axis is the number of weeks after the DJIA
peaked. The line descends to the lowest point in that decline and is then
horizonal from that point until it reaches the scale on the right. All
lines start with the value of 1.0. A
decline ending at 0.60 on the scale, for example, means a 40% loss of the
starting value. The thick green line is
the current decline.
Figure One – Nine Major Price Declines Since Early
The line shown by “A” is the decline beginning in 1929. The DJIA declined over a period of 148 weeks,
to 7/1/1932, to a value of about 0.13, or 13% of its original value (scale on the right), which
means that the DJIA lost about 87% of its value during that decline, definitely
a startling loss.
The line by “B” is the decline that began after the peak in
prices on 2/14/2020 and relates to the COVID crash. This decline was even
steeper than the early weeks of the 1929 decline. The DJIA took only five weeks to reach the
bottom of the 2020 decline. It declined
to 65% (scale on right) of the value it had on 2/14/2020, representing a loss of
Figure One presents a reasonable comparison for the current
decline (shown with the thick green line) showing the depth and duration of
major declines since early 1929. Against
this backdrop, the current decline has a relatively short duration, which is
consistent with the MRI conditions indicating that the bottom of the market is several
weeks away. When the bottom of the
market does arrive, the DJIA will likely be at a lower level than it is now.
Excluding the decline starting in 1929, all other declines
ended at values between roughly 0.45 and 0.80, representing losses of about 20%
to 55%. The current decline for the DJIA, shown by the heavy green line, is
just approaching that range with a roughly 17% decline so far.
For clarity, Figure Two below is the same as Figure One but without
the declines beginning in 1929 and 2020. The depth and duration of the 1929 decline should be kept in the back of
our minds but we are not likely to have a decline of its scale in the
near-term. Policy makers made several
mistakes during the 1929 decline, which I referenced in an earlier note.
The 2020 decline is not applicable to the current decline
because it was ended by extraordinary stimulus around the world. Stimulus of
that scale seems less likely to occur for this decline because there is recognition that the stimulus implemented to address the 2020 decline may have magnified the inflation challenge we now face, and the Fed has indicated
that it will aggressively fight inflation by increasing rates and reducing other
measures supportive of the markets. See endnote #1.
Figure Two – Major Declines Excluding 1929 and 2020
The heavy green line in Figure Two (and Figure One) represents
the current decline, after prices peaked 1/7/2022. As of last Friday (6/17/2022), we were at
week 24 and the DJIA is at 0.83 of its beginning level, which means a 17%
loss. The other declines shown in Figure
Two had an average loss of 9% by week 24.
Thus, the current decline is comparatively steep.
The orange line by “C” is shows the path of the decline that
began in 2000, after the Dotcom bubble. Especially
over the last few weeks, the market has experienced sharper losses than the 2000
decline. It is no longer reasonable to
compare the current decline to the 2000 decline.
Of the declines shown, the average total decline was 39%,
and this may be a reference point to consider for the magnitude of decline that
may transpire for the current decline. This
is not a forecast, but simply an observation to help frame expectations.
Valuations Suggest that Prices are Not Yet Low
Figure Three below shows the price of the DJIA (brown, log
scale, right) since 1993, along with the Price/Book (purple) and Price/Sales (blue)
ratios. Valuation data for earlier dates
is not available through my data sources. The current readings are at the far right of the figure.
All else equal, lower valuation ratios are more attractive
for purchasing stocks. After a period of
price declines on investor concerns about the future, unusually low valuation
ratios entice investors to buy even when the future is questionable. We can see from prior declines the valuation ratios
that enticed investors to buy.
The ellipses show the levels of these ratios at the bottom
of the major declines of the period from 1993 to the present. In all cases, the current ratios are higher
than the levels at the ends of prior declines, suggesting that the current ratios may need to decline further to attract investors. The current level of the Price/Book ratio (purple, left scale) is
4.0. This means that the current price
of all companies in the DJIA is four times the sales of all those companies. The average Price/Book value for this entire
period is 3.3. The value of this ratio
at the bottoms of the prior declines indicated is 3.0 or lower. Thus, the current value is still high by these
The Price/Sales ratio (blue, also on left scale) is
currently 2.1, meaning that the price of the DJIA companies is just over twice
the sales of those companies. The
average Price/Sales value for this entire period is 1.4. For the end of the 2000 decline in 2022, the Price/Sales
ratio was about 1.0. In 2009, it was 0.6. In 2020, the lowest value was 1.4. Thus, the current value is still high by
these historical standards.
The high valuation ratios of the last few years have been
more acceptable to investors because interest rates have been low. Low interest rates tend to boost economic
growth, and high economic growth justifies high valuation ratios, all else
equal. Low interest rates also give the
long-term future growth of book value and sales a greater weight in determining
the current fair value of a company. But
when interest rates move rapidly higher, strong future economic growth is
called into question and any growth that does occur in the distant future has
less weight in determining current fair price of stocks. Thus, a sharp move higher in interest rates
has these two important effects.
These forces can cause investors to care much more about the
near-term prospects of a company. Companies
with weak near-term earnings but promises of high future growth can be shunned
by investors because the rosy future may not materialize as expected. Therefore, indexes that are heavily weighted
to companies promising high future growth, like the NASDAQ stock index, can become
relatively more vulnerable to price declines. We are seeing this in the
performance numbers reported below – the NASDAQ has had greater losses this
year than the DJIA.
While the above material describes the context of the
current market, our portfolios are influenced more by the MRI. The MRI indicate
that the stock market will continue to be vulnerable to declines for several
stock market has declined from December 31, 2021 through last Friday. I have calculated the returns that one would
get by following instructions since the beginning of the year for the “main”
portfolios for each of the publications. Please see endnote #2 for a brief
comment on the main portfolios. Contact
me with questions.
year-to-date returns as of 6/17/2022
These returns compare favorably to the following alternatives:
IEF: -12.4% ETF for the US 7-10-year Treasury bond index, with no leverage
VBINX: -18.9% Vanguard Fund with 60% of assets in stocks and 40% in bonds
VASGX: -19.8% Vanguard Fund with 80% of assets in stocks and 20% in bonds
1 - Well before COVID, we had an extended period of exceptionally low interest rates. During that period, policy makers around the world tried to get inflation to move higher. The Fed wanted to get inflation up to 2% and was struggling to induce inflation by keeping interest rates exceptionally low. During this period, the prices of many assets went higher. Stocks, bonds, real estate, cryptocurrencies, etc. rose in price. Then COVID came along, and the government added even more stimulus to keep the economy from falling further than it otherwise would.
Inflation has gone higher – much higher - than policy makers expected. In response, the government support is being retracted. Most notably, the Fed is pushing interest rates higher. As rates go higher, all the assets that seemed reasonably priced two years ago are seeming more expensive. Stocks, bonds, real estate, cryptocurrencies, etc. are now moving lower.
The MRI started to indicate greater market vulnerability in the middle of 2021. From this perspective, a good portion of what we are experiencing was already in motion at that time. The war in Ukraine and the resulting boost in energy prices has added to inflationary pressures but does not appear to be the sole cause of the inflation we are experiencing. The MRI indicate that forces over many years contribute to the current conditions. From this perspective, addressing the weaknesses in the stock market and probably the economy will be a long-term effort. This further supports the view emanating from the MRI that we have several weeks to go before the decline ends.
2 - Main Portfolios
The main portfolio in the Diamond publication is sg235. The main portfolio in the Sapphire publication is sg325.
If you use either of these as your long-term portfolio and have followed the instructions since the first of the year by switching to the target weights of a less aggressive portfolio (by following the specification for Box #3, i.e., “-1”) and holding Box #2 Cash as instructed, your account’s performance should be close to the figure above.
Some deviation between your account and the numbers above can be expected. The performance figures above assume trading is done at the close of trading on Fridays. Most people trade earlier in the day. In addition, we sometimes trade before Friday. If you use as your long-term portfolio one that is more or less aggressive than the main portfolio, your actual performance will be different.
The figures above are based on the actual ETFs in the model portfolio. The figures in the weekly publication are based on the index that the ETFs track.