Some of your statements are very telling. In one statement you say that:
"Due to very low inflation in most industrial countries, Joe average is looking for more profitable returns on his money than maybe th 3% fixed interest rate the banks will offer him. So where does his money go, more than likely direct into stocks or an investment fund."
Indeed this is a good explanation for how we got where we are. But does it tell the future? You neglect the fear vs. greed aspect of the stock market which is ever present. The last 10 years has clearly been dominated by the greed factor, which you clearly state. But if the stock market actually begins a bear cycle, then how long will investors tolerate negative returns? After all, the only reason they are in equities is because they expect greater returns. Once that expectation ceases to exist or the risk becomes apparent (i.e. fear), will they remain?
In the last several years we have seen dips followed by the return of small investors who have driven the stock market to new highs. Clearly those highs are out of line with historical valuations even accounting for the lower inflation and interest rates. This is only natural, so long as the confidence exists in rising earnings, growth, and new highs. Dips are bargains. But eventually we will have a recession. And eventually we will have declining corporate earnings. On individual issues when earnings have declined we have seen precipitous declines. In a recession we would see declines in earnings that affect many of the larger companies. If you are suggesting that in the face of declining earnings investors will continue to drive up PE multiples so as to keep stock prices rising, I have no doubt you are mistaken.
My question to you is, if the stock market starts down, how long until the small investors stop allocating all their 401K money to equities? I have no doubt that the small investors will probably end up holding the bag, as they usually do. This could happen in the following way: First the smart money withdraws, leading to a first dip. This bring back life to the big time shorters, which makes subsequent rises difficult. Sequential down quarters cause small investors to begin putting their money elsewhere, the decline gets worse, and then the decline accelerates. Finally the bottom would be marked by the absence of the small investor.
I am not forecasting this right now, but I do believe it will happen some day, and it could happen now - in fact I believe it will happen at the beginning of the next recession, whenever that is. I remember the cycles between 600 and 1000 during the 60's very well. During that period the best way of determining tops and bottoms was odd-lot activity. In other words, if small investors were active, it was a top. If they were gone, it was a bottom.
Indeed low interest rates are conducive to rising stocks, but real interest rates (interest rates minus inflation) are still extremely high. Thus interest rates do provide a good investment alternative even at the current time, and I believe that given fear, investors may well prefer less return (but one still greater than inflation) to an investment that is yielding negative returns.
Good luck,
Carl |
