My first employment out of graduate school at Vanderbilt was with the New York
firm of Kidder, Peabody & Company. The firm brought people in to discuss various
pertinent topics to the training class.

For economics we were lectured by a Professor Gamerov. He posed the following
question to the class: when are markets stronger, at the top or at the bottom? Most of the
trainees said at the top. Previously we had been lectured by a technician who spoke of the
concept of “relative strength”. A stock going up more than the market was considered
stronger or more likely to keep going than one who was not.

Professor Gamerov would have none of that. Markets were weakest at the top, he said,
because at the top there is no one left to sell to, which is why markets turn down from the
top. At the bottom markets are strongest because there is no one left to buy from. This is
how bottoms are formed.

According to current valuations, the aggregate value of the stock market is either at
an all-time high or close to it, depending on the yardstick used. The average P/E ratio is
22 vs. a historic average of 16. The dividend yield on the Standard and Poors 500 is 1.5%,
again below its historical average. Over 58 percent of American households’ own stock,
above the historic average of 53 percent.

Some would see this data as a vindication of participatory capitalism. If people
knew what they were investing in this might be the case. But most people are investing
through packaged products like ETFs and mutual funds at the behest of their friends or
asset allocators. They have no clue as to what they are buying but rely on the fact that the
investment is going up.

An excellent proxy for this is the bitcoin ETFs. Most investors cannot tell you
where the value of a bitcoin comes from. They only know supply exceeds demand, which
is why bitcoins go up. The SEC, under unrelenting pressure from the brokerage industry
to provide a vehicle for the general public to participate in bitcoins, recently approved the
sale of bitcoin ETFs. Usually, public participation in an investment trend is the last chapter
of a mania. Think of non-publicly traded real estate investment trusts, oil and gas
partnerships, options programs, commodity pools and the like. Going back further,
consider the listing of tulip bulbs on the Amsterdam stock exchange in 1749.

All of these investments were designed to attract funds from the least
knowledgeable so that the more knowledgeable could cash out. Another example of this
was the Shenandoah & Blue Ridge Investment Trusts, a forerunner of today’s closed-in
mutual fund. Started in 1928 by Goldman Sachs for the purpose of giving access to the
public in the investing in the electric utility industry in a way the offered diversification
across several companies, the fund fell 98 percent in value after the stock market crash
of 1929. Goldman Sachs spent most of the 1930s recovering from their association with the
venture which almost did the firm in.

Valuations are tricky things. They are easy to record but difficult to predict. The
valuation of specific investments are not the same as valuations of entire markets. The
bitcoin craze, sports gambling and the like almost seem to be saying that valuations do
not matter. They do matter once they can no longer be ignored. This realization usually
occurs after the fact. Losses have a way of doing that.

The Economy

Economic activity continues at its slow and steady pace. Housing continues to be
impacted by interest rates. Demographic demand drives healthcare. Consumers seem to
be moderating their spending. Record levels of consumer debt has to be examined in the
context of record numbers of consumer households.

Economists see moderating demand for 2024. Government spending in the form of
public works is increasing as the projects funded by the Inflation Reduction Act break
ground. Growth is still expected to be positive at a bit less than two percent this year net
of inflation.


Inflation is captive to international events. The disturbances in the Red Sea seems
to suggest that energy prices may be more prone to rise than expected.

Wage inflation persists. This is due to a combination of demographics and lack of
a clear immigration policy. Political constructive discussions has not constructively
occurred for quite some time. Until this happens the matter is not expected to be resolved.

Interest Rates

The parlor game of “when will interest rates be cut? is in full swing. The reality is
that the one party that can bring it about—The Federal Reserve—is mum on the details.

Without an economic downturn there seems little incentive for the Fed to reduce
interest rates. Given how much debt of the US government is sold to foreign investors,
the Fed will need to consider how much that market will be scared off if interest rates
were to be reduced faster than the rest of the world.

The Stock Market

The stock market is playing the same parlor game as the bond market in trying to
predict the decline of interest rates. This is in large part due to the corrosive effect above
inflation interest rates have on valuations. In addition, a moderation in the growth rate for
profits begs the question of what growth there will be in corporate profits.

With the largest growth companies announcing invasions into each other’s turf, it
is a matter of time before their growth slows as well. Stocks that will do well in this
environment will have specific strategies and not depend on their association with an

Warren M. Barnett, CFA
January 16, 2024

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