U.S. Stocks Look Like They're Still Headed Lower

US stocks might have bounced off their lows but have only retreated to the fair value levels of 1991. Typically stock markets tend to over-correct, so we are not at the bottom yet, though it might not be that far away now.

Warren Buffett’s mentor Benjamin Graham looked at stock prices against their 10-year average earnings per share to gauge value. On that reckoning stock prices are only sightly cheaper than their long-term average for the first time since 1991. Stocks have been overvalued for a long time.

Down trend

Could a long period of sub-average valuations follow for stocks? Perhaps but we clearly still have to find a bottom in stock prices first. They always over-correct on the way down, a reverse of the irrational exuberance of the upside.

How long will that take? The most optimistic point to the spring next year but increasingly experts suggest the middle of next year might be the time to buy, presumably after people sell in May and go away.

To support the Graham analysis you can also turn to the q-theory. This considers the market capitalization of a company compared to the net worth of its assets. But again we sadly only arrive at the fair value position, and there is no buying signal.

Sell, sell, sell

In short, at this stage any rallies in stock markets should be seen as selling opportunities, if by mischance you still have US equity investments - and by implication most global stock markets will also follow this trend so lighten up there as well.

This column posited 7,000 on the Dow and 3,300 for the FTSE at the start of the autumn, and we nearly got there. It looks like 2009 will see even lower index numbers, and even then it is going to be hard to call a true bottom recalling the 1930-32 down wave (see graph).

How far US economic policy will offset the depressionary forces in place is the big call for 2009. But it is notable that at least economic policy is different this time. Whether it will work is another thing.

Could gold and silver stocks be the exception to this down wave? That was the experience of the 1930s and a coming dollar collapse would likely be the backdrop for a repeat performance by the precious metals sector.

Comments

[investor88:]

Very good article puts things in perspective to those now calling for a Christmas bull. To be sure no harm for short term traders to go long but with stop loss so this trading stance is not inconsistent with Peter's article calling for selling into strength US and emerging markets.

On balance I am very wary and on the bearish side longer term but for Dec 08 the bulls might have the upper hand. Dow 7k or lower [in time to come after this rally] is entirely possible if deflation continues despite all the monster bailouts.

2008 Nov 30 07:20 AM

[Pauly B:]

The market is discounting alot of bad news, but put buying remains high, and any single piece of good news sends the markets flying. Extremely difficult to trade or invest even for the most seasoned. Im staying out of the way for awhile.

Company Earnings, Company investments, IPOs, and jobs numbers improvements are lagging indicators of a bottom The big question remaining will the government stimulus packages really do anything? So far I dont see it nor do I see any improvement in the above.

2008 Nov 30 08:50 AM

[long_on_oil:]

You have one huge difference between now and the great depression and that is government transfer payments and retirement disbursement ie Social security, teacher retirement, corporate pensions, 401ks etc. These payments place a floor on earnings you did not have during the great depression.
In other words Wal Mart is going to do well no matter how low the market gets.
These payments also insure the dow will not fall below a specific level, even though I don't know what that level is. If I were to guess I would say probably 7000.
Retirees purchase automobiles, clothing, medical etc. The healthy ones still go on vacation and buy RVs. It is the level at which the purchases are made that is lower.
Investors are finally starting to realize that the economy is starting to bottom t and there is tremendous value to be had. That is why the market has gone up 5 straight days. Investors are finally reaching a point where they are refusing to sell. The number of shares available for the day traders is getting below the demand so the prices are rising.
Low gasoline prices are bringing the economy back. The price of gas will probably level off at around $2.50 a gallon after oil settles in around $75 a barrell. When that happens the economy will level off for a couple years and then slowly recover.
Just my opinion.

2008 Nov 30 09:17 AM

[G. P. Rouse:]

Remember that in 1927-1929 the market was almost up 200% in that short-time period - a much steaper amplitude for that period. It was very similar to the Nasdaq bubble than to the recent market crash. If you look at the 100% rise in the DJIA in the last 5-7yrs, it has all been wiped out. But we had nowhere near the ascent of the market during the roaring 20's - although some emerging markets do have similar charts like the DJIA in 27-29.

2008 Nov 30 09:24 AM

[Dr.Jackpot:]

80% of recent selling has been for tax loss reasons. This is ending now and typically at the beginning of Dec repurchasing starts so that certain holdings can be shown at year end by funds. Stocks will mostly rise or at least stay flat for the rest of this year. If you bought during the frenzy of tax loss selling you just made a bundle if you hold into January.

2008 Nov 30 10:07 AM

[Jimmy Lathrop:]

What would have been a better ending to this article is a conclusion such as, in the near term it appears the bond market may outperform equities, or maybe a conclusion that a cash position would be better than long equities, but no, instead, we are urged to start a new speculative bubble in gold and silver stocks, with no analysis or data, just a faint urging. Football is played for 4 quarters. Just ask the Patriots who had an almost perfect season until the Giants won last year's Superbowl. This article ran out of gas just like New England.

2008 Nov 30 10:33 AM

[FB5000:]

We have seen the equity bottom. The recession will be over by mid 2009. Late 2009 will see rising growth and increasing price pressure. 2010 will see more growth and by mid 2010 rising Fed interest rates. The next 18 months will be good for equity markets in the U.S and overseas. There is a tsunami of money building up behind the dam. You don't want to be on the otherside of this - especially when the Fed. controls the wrecking ball.

2008 Nov 30 02:41 PM

[FB5000:]

One other thing. These sort of articles are similar to driving by looking into the rear view mirror. Comparisons to the 1930's are getting incredibly tired as is comparing to Japan in the '90's. The Fed is getting teady to print money - Bernanke will do what he can to reflate - he will stop at nothing - same for the Congress - the helicopter drop will be used - if necessary. The single biggest risk now is inflation. It is coming and the real issue to worry about and to write about is how to manage the next bubble and to prevent the inevitable.

2008 Nov 30 03:14 PM

[RWM:]

Read "North American Long Waves-Baby Boomers, Generation X and Social Cycles" by Edward Cheung; ISBM 978-1-896330-06-8(v.1)

2008 Nov 30 04:59 PM

[happysoul77777:]

Sell and sell more....

The Federal Reserve is on the side of the bulls, but the FASB accountants and the SEC are on the side of the bears.

2008 Nov 30 05:38 PM

[Kunst:]

If you are going to toss in a passing mention of "a coming dollar collapse", maybe you could take a few more words to say what you expect and why.

2008 Nov 30 06:41 PM

[Fabien Hug:]

FB 5000, I'd like to read more articles based on your assumptions. On one hand we have those who predict more doom without taking into consideration the huge amounts of money that are force fed into the economy (OK so far these amounts have been used to repair balance sheets but it is still a lot of money) and, on the other hand, some cry for more (see Baron's article in today's SA) and then what. Nobody seems to care or maybe it is not the place to care.

2008 Nov 30 07:00 PM

[Steven Hansen:]

"Investors are finally starting to realize that the economy is starting to bottom t and there is tremendous value to be had." - long_on_oil

????? except for the prices of oil and other commodities, what economic indicator are you looking at? what will be the driving force for recovery? how will we deal with the mounting private and public debt and all of the government guarantees?

of course the economic free fall will stop. i also think it will happen sometime in 2009 too. but recovery is a different subject. this is not 1929, but we unfortunately have some elements of Japan.

the stock market is not the economy. the market does what the market does. the market big guns believe a big market recovery is pre-ordained using their past models and data. the market will act accordingly.

2008 Nov 30 10:20 PM

[Pipo:]

Marc Faber and Jim Rogers think markets will rally till early next year.

www.jimrogers-investme...

2008 Dec 01 12:46 PM