Neither stocks nor gold moved much yesterday…
“Wait and see,” remains the order of the day.
The Greeks, for example, have 48 hours to come to terms with their creditors. We wait to see what will happen.
We wait to see what happens in the bond market, too.
Have bonds topped out?
Hard to say…
For six years the Fed and other major central banks have made a bad situation worse.
By promising to keep the cost of carrying debt ultra-low, they have encouraged governments and businesses to add trillions of dollars in debt to an already debt-drenched economy.
Until recently, bond prices have been going up. Surely, that is going to reverse…
While we’re waiting, let’s check on our new Trade of the Decade.
Regular readers will recall that the concept is simple…
You buy what’s been going down for a long time, and you sell what’s been going up. Or put another way, you buy what’s cheap, and you sell what’s expensive.
Our original Trade of Decade – to buy gold and sell U.S. stocks – did well. Gold rose 289% between 2000 and 2010. The S&P 500 fell 23.
But it was time to move on. Gold was no longer cheap. And U.S. stocks were moving up.
We looked around. What was cheap? What was expensive?
And there, hiding in the corner, was the poor, forlorn, and neglected Japanese stock market.
After a 20-year bear market, the Nikkei – Japan’s equivalent of the Dow – was trading below 10,000 points. That was down from 39,000 in 1989.
We knew nothing about Japan… nor about Japanese stocks. But they looked like they needed a friend.
And since we are always kind to the underdog, the die-hard, and the lost cause, we decided it was time to give the Nikkei a friendly pat on the head.
“Buy Japanese stocks,” we said.
What to put on the other side?
What bothered us was the yen. What if we were right about Japanese stocks, but the yen went down?
Thanks to a weaker yen versus the dollar, that would wipe out much of our Nikkei profits when converted back into dollar terms.
Besides, in the race to destroy their currency and their economy, the Japanese were far in the lead.
They had already run up government debt of more than 200% of GDP. And with its population getting older, and Chinese exports becoming more competitive, it was hard to see how Japan’s debt problem could be resolved happily.
The Bank of Japan would be forced to buy bonds, by way of QE, to help keep Tokyo’s debt service costs low. This would raise government debt to unsustainable levels… and eventually drive Japanese investors out of bonds.
Where would they go?
So, we killed two birds with one stone. (Not that we have anything against birds. We don’t have anything against Democrats and Republicans either. Still, if you have a stone in your hand it’s a pity not to put it to good purpose.)
We’re now halfway into the decade. How’s it working out?
A headline in yesterday’s news:
“Japanese stocks highest since 2000.”
Turns out, the Nikkei has doubled, from under 10,000 in 2010 to over 20,000 today. A 100% profit.
But how about the other side of the trade? How ’bout dem bonds?
Shinzo Abe came into Japan’s top office promising to get the economy up off the floor. This he would do, he claimed, with “three arrows.”
The first was monetary policy (essentially, devaluing the yen). The second was fiscal policy (digging an even deeper debt hole for the government).
And the third?
“Structural reforms,” which could be any damned thing they could think of.
We could have given Abe a much better program: Balance the budget, make the yen convertible to gold, and repeal all legislation that affects the economy.
But nobody called us.
Meanwhile, the price of the 10-year Japanese government bond is down 1% since the start of the decade.
So far, so good. Both sides of the trade working well.
Only five years left to go…
The S&P 500 just hit an important milestone…
It now trades at 18.7 times reported earnings over the last 12 months.
Put another away, investors are paying nearly $19 for every $1 of earnings the companies that make up the index have generated since last June.
That’s now higher than the average trailing price-to-earnings (P/E) ratio of 18.3 at the end of all 14 bull markets (including the current one) going to back to 1928.
And of the 13 previous bull markets, seven have ended on a P/E of 18.7 or higher. These are shaded in gray in the table below.
U.S. stocks aren’t cheap. But half of all bull markets have seen P/E ratios go higher than where they are today.