Are Stocks Returning to Normal?

Maybe, just maybe, the stock market is starting to return to normal... I'm still bearish on the overall stock market. I still think U.S. stocks are bumping against their most expensive valuations in history, according to all the metrics that have correlated most closely with historical returns. For example, the price-to-sales (P/S) ratio of the […] Not rendering correctly? View this e-mail as a web page [here](. [Empire Financial Daily Weekend] Are Stocks Returning to Normal? By Dan Ferris Maybe, just maybe, the stock market is starting to return to normal... I'm still bearish on the overall stock market. I still think U.S. stocks are bumping against their most expensive valuations in history, according to all the metrics that have correlated most closely with historical returns. For example, the price-to-sales (P/S) ratio of the benchmark S&P 500 Index has negatively correlated with subsequent 10- and 12-year average annual returns about 90% of the time since 1928. In other words, when valuations have been high, the returns that follow have been low. Today, the P/S ratio of the S&P 500 is 3.17, meaning share prices of America's biggest companies are more than 3 times higher than their sales. That might sound like a lot, and it is... The P/S ratio of the S&P 500 now is 35% higher than it was at the peak of the dot-com bubble. I could cite plenty of other metrics, but you get the picture... I still expect a drop in the S&P 500 in line with previous all-time high valuations, somewhere between 50% and 65%, and an even bigger drop for many individual stocks. I feel like that drawdown is within sight. That's what I mean by "return to normal." And I promise, as painful as it would be for those who aren't prepared for it, a bear market in stocks would be a very good thing in the long run. The more investors grow accustomed to high valuations getting higher, the more distorted their thinking becomes... the more inclined they'll be to engage in dangerous speculations... and the worse they'll be blindsided when reality reasserts itself (as it always has and always will). So, when I say, "Maybe the stock market is starting to return to normal," I mean that today's valuations are way above normal, and maybe that's all about to change over the next several weeks and months. Here's why... The first reason I think we're headed back to more normal valuations is that some of the most egregious signs of speculative frenzy appear to be behind us... I'm talking first and foremost about "meme stocks." The most popular one today is movie-theater chain AMC Entertainment (AMC). The stock's 52-week low is $1.91, reached on January 5 of this year. Its 52-week high is $72.62, achieved on June 2 of this year. That's right... It became a 38-bagger, a 3,700% winner, in slightly less than five months. Today, a little more than two months after becoming a 38-bagger, AMC is trading closer to $30, a drop of more than 50%. Shares are still egregiously overvalued, but the fact that they're down more than 50% is reassuring to me. It could be a sign that the market feels like it sucked in enough losers and is ready to show them what happens when you have no idea what you're doing. The other famous meme stock, video-game retailer GameStop (GME), looks about the same. Its 52-week low, hit on August 7, 2020, is $4.06. And its 52-week high, reached on January 28, is $483. That's a 119-bagger from bottom to top. It's trading in the $150s today, down nearly 70%. Short sellers are wading back in to at least one meme stock... I also noticed that, about a month ago, AMC canceled plans to sell as many as 25 million new shares for proceeds of approximately $1 billion. The Financial Times reported that AMC appeared "to have hit the limit of what its existing shareholders will tolerate." Then, just last week, a report came out that said Odey Asset Management, a fairly well-known hedge fund, had taken a short position in AMC. In a letter to investors, Odey manager James Hanbury told clients that retail investors' frenzied meme-stock speculation was among several factors that have "created major distortions" leading to "compelling short opportunities." You might recall that the meme stocks soared so high so quickly because retail-investor buying prompted large hedge funds to buy to limit rapidly growing losses in large short positions. With $4.1 billion under management, Odey is not enormous by today's standards. But the fact they're willing to step back into the fray tells me perhaps they believe the worst craziness is finally behind us now... that the meme stocks will trade more in line with their business prospects. AMC owns movie theaters and has $11 billion in debt. GME owns stores that sell old video-game disks. Both businesses have been in decline for a decade or more. These stocks traded in the ballpark of 0.1 times sales before all the meme-stock nonsense. Today, AMC is around 14 times sales, GME around 2. A return to pre-nonsense levels would send both stocks down to roughly 95% or so below current levels, and closer to 98% or 99% below their meme-era highs. Odey's AMC short is the right way to bet – if you must bet at all. In this case, I see that the market is getting back to its long-term job of assigning asset prices that reflect the fundamentals. --------------------------------------------------------------- Recommended Links: [Announcing Jeff Brown's first-ever crypto livestream]( Early backers in ethereum are up as much as 1,007,319%. After seven years, its inventor is launching his newest crypto project... and setting aside up to $2.9 billion worth of his project's new coins as a reward. On Wednesday, August 25 at 8 p.m. Eastern time, Jeff Brown will explain everything. [Reserve your spot here](. --------------------------------------------------------------- [Dan Ferris: 'This is the smallest stock I've recommended in seven years']( As one of the best value investors in the world, Dan Ferris has racked up an impressive track record. But his new pick has people talking. It's the smallest company he's recommended since 2014. Find out why he's so excited [right here](. --------------------------------------------------------------- When a stock goes up 119 times in a few months, you know markets aren't 100% efficient... Markets can make big mistakes. That's why you must learn to ask if the market is accurately measuring the value of the company, or if the company's price is accurately measuring some flaw in market participants' thinking. It's a classic case of "Wittgenstein's ruler" – a term coined by trader and author Nassim Taleb in his book Fooled by Randomness and named for Austrian philosopher Ludwig Wittgenstein. Using the example of book reviews, Taleb explained the idea of Wittgenstein's ruler. As Taleb wrote... A book review, good or bad, can be far more descriptive of the reviewer than informational about the book itself. This mechanism I also call Wittgenstein's ruler: Unless you have confidence in the ruler's reliability, if you use a ruler to measure a table you may also be using the table to measure the ruler. The less you trust the ruler's reliability... the more information you are getting about the ruler and the less about the table. That last sentence pulls it all together and tells you why it's an important idea for investors. If the ruler – stock market pricing – is not reliable, you need to remember that and learn to spot the times when it's not giving you a helpful measurement. The most naïve investors believe that the meme stocks near their peaks were being accurately measured by the market. But really, the ruler was flawed, and the stock prices were measuring just how insane locked-down, stir-crazy speculators hopped up on stimulus checks and claustrophobia can get. And like Taleb said, when the table is telling you more about the ruler than the ruler is telling you about the table, the ruler is not reliable. The market prices of GME, AMC, and other meme stocks were simply not reliable. The market for those stocks was – and still is – badly broken. Although, not by as much. Their recent price action... AMC's inability to keep milking the broken market for new equity money... and Odey's willingness to wade into an area that closed down at least one hedge fund (Melvin Capital) suggests that maybe, just maybe, the weighing has begun. No matter where I go, I can't completely escape the feeling that financial markets aren't acting right today... The skeptic in me says that the meme-stock trade washout could be just another rotation from one bubble and into another that hasn't started yet. It reminds me of an old bumper sticker I heard was found on cars in Silicon Valley after the dot-com bubble blew up. It said something like, "Please, God, Just One More Bubble." And one more after that... and one more after that... in an endless series of rolling bubbles as investors genuflect before the U.S. Treasury and the Federal Reserve (and the Holy Ghost?) and rotate from one speculative play to another... anything to get rid of their cash. Gee... When you look at it that way, the meme-stock folks gambling away their stimulus checks don't look quite as crazy. What should you do? I can answer that question. Prepare, don't predict. Preparing means holding stocks, bonds, plenty of cash, silver, gold and maybe a little bitcoin if you're comfortable with it. To be fair, you could also argue there has never been a time when the stock market was a better measuring stick than it is today. There have always been speculative episodes, and as long as humans are humans, there always will be. Once again, though, that only means that you need to understand when prices are measuring asset values... and when asset valuations are measuring investor appetite for increased risk. Most people don't even know there's a difference. Instead of speculating on stocks that are virtual 'lottery tickets,' I'm looking at world-class companies that can help you build long-term wealth... Too many of these folks today are trying to get rich quick. Whether they know it or not, they're gambling with their hard-earned money. And they certainly don't have any kind of long-term plan. I recently identified one stock that checks all five of my "boxes" of a high-conviction investment opportunity. I think the upside is so great that I just published a presentation where I explain exactly why I'm so bullish on this stock. [You can watch it for free here](. Regards, Dan Ferris August 14, 2021 If someone forwarded you this e-mail and you would like to be added to my e-mail list to receive e-mails like this every weekday, simply [sign up here](. © 2021 Empire Financial Research. All rights reserved. Any reproduction, copying, or redistribution, in whole or in part, is prohibited without written permission from Empire Financial Research, 601 Lexington Ave., 20th Floor, New York, NY 10022 [www.empirefinancialresearch.com.]( You received this e-mail because you are subscribed to Empire Financial Daily. [Unsubscribe from all future e-mails](