Book Reviews

Book Review: The Wall Street Waltz – 90 Visual Perspectives

Book: The Wall Street Waltz – 90 Visual Perspectives (Illustrated Lessons from Financial Cycles and Trends) by Ken Fisher

Review: Quite a few interesting points. I always think that history is a very good teacher and one really need to look at history and learn what were the pitfalls so that you can avoid them. That will be much more efficient that committing those pitfalls yourself and paying a high price (both in terms of money AND time) to learn those lessons which can be learnt in a much shorter time by reading and thinking.

Key Points:

  1. Stock Market
    1. Prediction Powers of Ratios
      • P/Es are not predictive of returns. Sometimes high P/E markets do well and sometimes they do badly. Sometimes P/E are high because the earnings are extremely depressed like during the Great Depression. Those are some of the best buying points. In 1929, the market P/E was around 15, people think that stocks were not too expensive and got fooled into holding their stocks into the depression.
      • When P/Es are high and people are fretting, markets keep doing well (1990’s latter half). When P/Es are high and people aren’t fretting, that can be bearish. When P/Es are low and people are bullish, it isn’t.
      • Average Price/Dividend ratio for Dow from 1920-1985 is 22.7. Price/Dividend, Price/Book, Price/Cash Flow are the same as P/Es, not predictive of returns.
    2. Stocks and Interest Rates
      • Equities compete with long-term fixed income for investor dollars. Compare bond yields (a pre-tax figure that needs to be adjusted for taxes) with earnings yield (an after-tax figure). When P/Es are high but long-term interest rates sustainably low, a higher P/E may be justified. When P/Es are high but long-term interest rates are high and rising (e.g. in the crash of 1987), high P/Es are an extremely warning sign.
      • When earnings yields are above bond yields, CEOs can borrow cheaply and buy back their own stock or acquire competitors using cash. Cash-based merger and buybacks boost EPS and increases stock prices.
      • It is difficult to predict stock market movements using short-term interest rates. Rising short-term interest rates can take a long time to take effect on the stock market (take effect meaning causing stock market to go down), so you can have periods where the stock market and the short-term interest rates are both rising (e.g. from 1944 to 1974, discount rate rose from 0.5% to 8% while DJIA rose from around 150 to 1000). Same for decreasing short-term interest rates.
    3. Price/Sales Ratio is Useful
      • Never buy a big company’s stock unless the company’s total stock market value is less than 40% of the annual revenues (i.e. Price/Sales < 0.4). Can use this as a check beyond looking at P/Es (e.g. in 1929, Sears’ P/E seems reasonable at 12 but the Price/Sales is between 1.05 and 2.37)
    4. Dow
      • Ignore Dow, use S&P 500. From 1965 to 1981, S&P has a 7.7% average annual return but Dow showed nothing.
      • 40-week moving average of the Dow can be a good signal.
      • To compare stock market index charts across different time periods, remember to adjust for inflation.
      • If you see long-term Dow charts, the charts before 1897 are inaccurate as there are no good records from that time.
    5. Correlations
      • Stock indexes generally follow the GNP but be wary and look at the long-term interest rates in each time period also.
      • Earnings and stock prices are tightly correlated in the long term. Interest rate fluctuations affect the P/E relationship in the short-term but in the long-term it is simply a cost of doing business that will be adjusted to
      • The world’s major stock markets have high correlation. Look at the other indices (e.g. London, Berlin, Paris) for warning signs of the market going down (e.g. in 1929 the other markets all dropped earlier.
    6. Recessions
      • Most people don’t know a recession has started until months after we’re into it. When you see stock prices falling, expect the economy to weaken in 6 to 12 months. When you see a recession, look for stock prices to be headed higher soon.
      • Earnings reports are announced at least 6 weeks after a quarter ends, so if business turns weak in the early part of the quarter, you don’t know about it until months later. Earnings can suddenly vaporize from a temporarily high reported earnings. Be wary when using strong earnings growth to justify that P/Es are not overvalued, be sure to use other data points.
      • Increased M&A activity does not mean the market is cheap. Usually it is the reverse, the more M&A activity the more heated up is the market (e.g. in the dot-com boom).
      • In major stock market crashes, the stock market drops an average of ~2% per month (e.g. 48% drop over 24 months).
    7. Historically, the market rises 60% of the time and falls 40% of the time.
    8. Cash-based M&A activity is bullish, stock-based M&A activity is bearish (too much stock flowing around and overvalued hence being used to buy companies).
  2. Interest Rates, Commodity Prices, Real Estate, and Inflation
    1. Real-estate’s long-term returns are poor compared with stocks. Big real-estate returns occur when people are highly leveraged when buying their home and real estate prices rise over an extended period.
    2. Inflation and real estate prices rarely increased when commodity prices are weak. Commodity prices need to go up first before it is reflected in goods and hence showing up as inflation.
    3. Weakness in commodity prices also mean that interest rates will not be high.
    4. Interest rates capture the market’s expectation for inflation.
    5. With the exception of a few periods, gold has not kept pace with inflation. From 1781 to 1981, gold appreciated at 1.58% per year. Gold shot up only 3 times in 200 years. Each of these 3 bull markets for gold lasted 3.7 years on average. From 1926 to 1981, gold increased 5.77% annually  but all the action came in 10 years.
    6. When England was the financial centre of the world, they can borrow money at very low cost. But as their economic situation falters, their interest rate cost increased.
    7. Oil price and interest rates (e.g. 20-year Treasury yield) tend to fluctuate in the same direction.
    8. Look at real interest rates (i.e. nominal interest rates adjusted for inflation). This is especially important when nominal interest rates are high but actually very low or negative after adjusting for inflation. From 1790 – 1980, it is rare for real interest rates to go above 10% or to be negative.
    9. Wars bring about price inflation. Wars today however are on a smaller scale, and has less effect.
  3. Analyzing Business Cycles, Government Finance, and Quackery
    1. To benefit from a major stock market bottom, be fully invested whenever the civilian unemployment rate (seasonally adjusted) has just risen one full percentage point. The 1% rule will get you in the ball park of the market bottom within a couple of months. Cyclical stock market lows have not happened without first having a 1% rise in the unemployment rate. Typically the unemployment rate will rise at least 1% during the first 2/3 of a recession. Don’t expect a major stock market peak until after unemployment has fallen for at least two years.
    2. To compare capital expenditure across time periods, one way is to plot the capital expenditures for plant and equipment as a % of privately produced GNP.
    3. One way to compare energy dependence is by plotting the Kilowatt-Hour sales of the electric industry vs. the GNP. The slope of the curve shows how the dependence has increased or decreased.
    4. The size of the budget deficit or total federal debt is not the problem, what is important is the ability to service the debt. National debt needs to be expressed as a percentage of GNP. Real GNP growth and inflation help to shrink the % of debt to GNP.
    5. When the Government spends and accumulates debt, it is not allowed to capitalize the spending in the same way as a company. Even if the spending generates returns, it still shows up as debt and this is misleading.
    6. Debt is good because of the money multiplier effect. The Government should keep borrowing until the cost to borrow just equals the return on assets. The return on assets is calculated as the nation’s income (i.e. GDP) divided by the nation’s assets. In 2007, assets is around $111 trillion and GDP in 2006 was $13 trillion, so U.S. has a 12% return on assets. The cost of borrowing is around 6%, or 4% after tax. Hence the return on assets is three times the borrowing cost. More debt is good.
    7. When debt is paid back, it results in lackluster stock market returns and a not-so-hot economy. When President Andrew sold land to speculators to pay back all debt, it resulted in the Panic of 1837 and then to a depression that lasted until 1843.
  4. Ken Fisher is a strong believer of Kondratiev waves. Cycles are getting longer. Inflation inflates prices in some area, then there’s a crash and delfation wipes out whatever obsolete infrastructure the inflation supported.


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