Alpha Power Investing Newsletter

May 1, 2019

Keeping an Eye on the Big Picture

The stock market is and has always been something of a good news, bad news proposition.

The good news is that in the long run stock prices go up. Buying and holding the Dow Jones Industrials for a 10-year period has generated a gain roughly 90% of the time historically. This tendency to rise affords investors the potential to grow their wealth over time by simply letting their money work for them.

The bad news is that there can be and has been "trouble along the way." This is something of an understatement. The long-term advancing nature of the stock market is regularly interrupted by deep and prolonged periods of decline. The problem is twofold: 1) these declines are extremely hard to predict in advance, and 2) these declines can have a severely negative impact on an investor's long-term goals.

Precise market timing is a pipe dream. However, at the same time, bear markets typically do not just come out of the blue unexpectedly. Figure 1 displays the Shiller PE Ratio over the past 100+ years. This measure is not useful as a "timing" indicator. It does, however, provide some degree of perspective in helping investors assess whether the overall stock market is overvalued, undervalued or somewhere in between.

When the Shiller PE Ratio gets above roughly 21 or so, the market is considered to be "overvalued." However, it is critically important to remember that this does NOT constitute an immediate "sell" signal. It simply alerts us to the fact that the next bear market is "lurking" out there somewhere and reminds us of the need to "plan ahead for a rainy day." Sometimes a reversal can occur almost immediately, while other times there can be years of lead time before things go south. One other painful scenario that can occur following overvalued readings in the Shiller PE is a long, multi-year period where the market makes no net gain at all.

Figure 1 displays the eventual bear market decline following each "overvalued" peak reading starting in 1929.

Ultimately, each post-peak episode is different in how it plays out, but the results have invariably been painful for investors:

1929: The bull market continued with the stock market overvalued for almost two years. During the subsequent bear market the Dow Jones Industrial Average lost 89% of its value before bottoming out.

1937: Market reached overvalued level and quickly reversed, with the Dow losing 49% in just 7 months.

1965: After the long Post WWII bull market, the Dow topped out and essentially went sideways for 17 years, including a -40% decline in the 1973-1974 period.

2000: The market reached overvalued level in 1995 then continued to rally strongly for almost 5 full years before finally topping out. As the dot com bubble burst, the Nasdaq 100 lost 83% of its value from peak to valley by late 2002. The major market indexes ultimately went sideways for almost 13 years from the 2000 highs.

2007: The Dow lost -54% between late 2007 and early 2009 as the financial and housing bubbles burst.

As of April 2019 the Shiller PE Ratio remains very much in "overvalued" territory. Does this mean investors should "sell everything and head for the hills?" Not at all. This ratio does not give any indication as to when the market will top out. On the other hand, what the history in Figure 1 does tell us is that the likelihood that the next bear market will be "one of the painful kind" is extraordinarily high. As a result, while investors should not necessarily be selling now, they should be preparing for such a possibility.

If we saw a repeat of the 2008 bear market, how would you avoid simply riding it down to the bottom? If we saw a repeat of the 1965-1982 period or 2000-2013, how would you make money if the market went sideways for a decade or more? Now may not be the time to "act", but the history depicted in Figure 1 most definitely suggests that it is the time to "prepare."

Strategies that afford you the opportunity to miss out on even some portion of a devastating bear market - as the strategies offered by Alpha Investment Management do - can leave you far ahead in the long run, "whatever the weather."

Jay Kaeppel
Vice President and Director of Research
Alpha Investment Management, Inc.

Disclosures and Disclaimers: Past performance is not a guarantee of future performance. The information contained herein does not constitute and should not be construed as investment advice, an offering of investment advisory services, or an offer to sell or a solicitation to buy any security. Before investing in any fund and/or strategy, investors should consider the investment objectives, risks, charges and expenses of the fund/strategy and its investment options.  

The data used to construct the illustration above was obtained from third-party sources. While Alpha believes the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  

Alpha Investment Management, Inc. is a SEC registered investment advisor located in the State of Ohio. Such registration does not imply a certain skill or training and no inference to the contrary should be made. The information and opinions expressed in this document are for informational purposes only. Any recommendation or opinion made in this document may not be suitable for all investors. The information contained herein does not constitute and should not be construed as investment advice, an offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

© 2019 Alpha Investment Management, Inc.

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