The old-time fundamentalists have
Graham and Doddered
away from Wall Street, and nobody knows if they'll ever come back.
By the fairly rigid valuation model that people reckon the
is using, where for the
to be considered fairly valued its one-year forward earnings yield should be about the same as the 10-year Treasury yield, stocks are more than 50% overvalued.
Others, who have tinkered with their earnings-yield/bond-yield models to account for changes in the dynamics of the economy and in the makeup of the S&P, are generally saying the index is about 35% overvalued these days. Less, but still excessive. In the past, when such levels of overvaluation have occurred, there's been a major correction in stocks. Until this year, that is.
Models are useful, but they can also be pretty dangerous things. They simplify the world, and that is a good thing, because the world is a confusing place and we need simplification. But occasionally, for whatever reason, a previously good model stops working. When that happens, it's important not to cling to the old model. When the band on the wooly bear caterpillar is thick and yet winter is not severe, it's not winter that's wrong.
By the same token, it can be just as dangerous to give up on a model because of an anomaly. In markets, there is a long history of the "this time is different" chorus coming before a fall. It's something that Wall Street strategists, in assessing the current state of things, are well aware of. Yet they are also mindful of what happened in the late '50s, when it actually was.
Back then, many operated with the assumption that stock dividends should always exceed the long bond yield -- and when that stopped, trouble was coming. But something happened, the model stopped working and the people who continued to believe in it were marginalized.
"Valuations were much lower then than today, but those poor, benighted fools didn't know it, because they were the highest they've ever been," said John Manley, equity strategist at
Salomon Smith Barney
. "It was a revolution. We discovered we didn't have to have depressions."
And now, Manley wonders -- as he has for some time -- whether we've constructed a recession-free economy. Or, if not that, an economy where recessions occur far less often. In the midst of the longest peacetime expansion in U.S. history (and just a few months away from the longest expansion, period), it's something worth thinking about. "It's been 10 years since the last expansion," he said, "and here's the Fed and bond market keeping the economy on an even keel. Maybe recessions are no more systemic than depressions are."
And so, the old way of looking at things doesn't work. Maybe for good. Maybe just for now. Meantime, those who've had little patience for models have made out best. Said Manley, "It really has been a market where guts were more important than brains."
Turns out, that's a common thought after seeing stocks run without quitting from the October lows.
"I think there are a lot of reasons to be fearful," said John Bollinger, noted technical analyst and president of
you cannot deny that if
you had just loaded up the boat on over-the-counter Internet stocks, you'd be sitting pretty."
Bollinger has been forecasting volatility for a while now -- and, in that, he's been spot on. But he thought that the tenor of that volatility would be to the downside, that the Fed being in tightening mode would eventually cow the bulls. Instead, the market has continue to float higher, buoyed by an immense wave of positive sentiment.
It's when sentiment gets positive like that, however, that technicians like Bollinger really begin to worry. It generally means that most of the good news is already in the market and that investors are looking at the world through rose-colored glasses. Bollinger notes, however, that a lot of bullishness among investors doesn't mean the market's heading down. "It's not enough to just identify the surge in sentiment," he said.
In some respects, an excess of bullishness is like a boat where all the passengers have run to one side. In itself, that's not enough to swamp the boat. "That's just the precondition," said Bollinger. "Were a wave to come along and nudge the ship, in fact, it might sink. That's what we have to look for now -- the catalytic event that will take this sentiment excess and start sending it in the other direction."
But what could that event be? There is now a degree of complacency in the market toward the year 2000 problem, but it doesn't seem like there will be any major disruptions. And the Fed, a natural thing to worry about, seems at least temporarily out of the picture after Friday's benign November
"It doesn't unwind all the Fed fears," said Mike Cloherty, senior market economist at
Credit Suisse First Boston
, of the latest jobs data. "It's more of a 'buy some time' report than a 'put the Fed away' report. The labor market is still tight. The pool of available workers is still falling. You have to think they're likely to tighten in 2000."
But Cloherty also notes that the report does suggest that there will be limits to further tightenings. The economy is genuinely showing signs of deceleration. There is no longer any sense that the Fed may have fallen behind the curve. As a result, "it's unlikely they'll be extremely aggressive," Cloherty said.
The only important piece of economic data in the coming week, Friday's November
producer price index
, likely won't change that. Cloherty expects that the headline will be up on higher oil and food prices, but the more closely watched core, which excludes those things, will be unchanged. "We continue to see some of the commodity goods prices being a little bit worrisome -- in particular oil," he said. "But the final goods type of inflation that would really spook everyone -- we don't have any evidence of that."