Sideways Markets Are We There Yet?

By Vitaliy Katsenelson, CFA Chief Investment Officer Investment Management Associates, Inc.

Murmansk

Sideways Market Keeps Marching On

The bear markets were actually sideways markets
and happened the time

Market Cycles 101: Secular vs Cyclical

Secular Markets last 5 years or longer Cyclical markets last less than 5 years. Take place in side of secular markets. 1966-1982 Secular Sideways Market

Cyclical Markets:

Dow Jones Since 1999

Stock Market Math

Earnings Growth

P/E

Price
+

Dividend Yield
=

Total Return

Market Cycles 101: P/E and Es

E
Bull Markets

P/E

Start at P/E End at P/E

Low High

Returns
Adding 2 positives = great returns
Net-net earnings growth is cancelled out by P/E decline = a lot of volatility and no returns Adding 2 negatives = horrible returns

Sideways Markets

High

Low

Bear Markets

High

Low

Stock Market is Only Cheap if You

S&P is at 18 times 12 trailing earnings above average but not too expensive. But

Stock Market is Only Cheap if You

Earnings are inflated but unsustainably high corporate profit margins. Profit margins will mean revert (in this case decline). Profit margins mean revert because capitalism works higher profits attract more competition and earnings will decline.

In the Long Run Earnings Growth = GDP Growth

S&P 500 Earnings Last 10 years

=
2 4 2
Ex-Crisis Average 10 Year E Actual Average 10 Year E

$65 $61

$50

(& 500 30, 2013) (& 10 2003 2012)

=
38%

1,590 = 61 1,590 = 65

26 25

Stock Market is Very Expensive!!!

We are in Secular Bull Market If:

Profit margins continue to expand or at least maintain current level unlikely
Revenues (GDP) will continue to grow at good paces given the exciting macro picture (China bubble, Japan debt bubble, Europe, QEs ) maybe? Or maybe not? P/E will continue expand unlikely, past secular bull markets ended at this type of valuations

Brief Summary of Strategy and Analysis for Todays Environment

Be a buy and sell investor. Buy and hold is in a coma (see next chart) . Time (price) stocks through a strict buy and sell process. Buy when undervalued, sell when fairly valued. Time stocks, not the market: Market timing is very difficult. In the short run emotions are in the drivers seat.

Dont buy for the sake of being invested. Dont lose money by making marginal decisions. In the absence of good stocks to buy, be in cash. The opportunity cost of cash is not as high as in a secular bull market.
Increase your margin of safety: Fewer (better) stocks will be in your portfolio. Favor dividend-paying stocks. Dividends were 95% of the return in previous sideways markets. (Warning: dividends are part of the analytical equation, not the equation.) Look overseas -- increases return without increasing risk.
16

Thank You!
You can read full version of sideways market presentation here http://bit.ly/swpresentation Read articles at http://ContrarianEdge.com