It's Not a Great Time to Get Into Stocks

Stock markets are trying very hard to call current index levels as a bottom. That's why optimistic investors jump in every time the DOW goes down and we see especially large run ups toward the end by stock manipulators. The reason is that they want to set the tone for next day, if the DOW jumped by 100 points the previous day. Current optimism coupled with some manipulators is based on the theory that stocks are too cheap now. But investors are only looking back at the past 3 years for relative valuations. Since the past 3 years were actually the biggest run up years (e.g. Apple (AAPL) went from $50 to $200, Goldman Sachs (GS) went from $60 to $240 etc.), the stock valuation assumption itself is flawed. I wrote in previous articles that we are slowly clawing back towards more reasonable valuations. But, unfortunately, some investors get fooled into buying at these levels which, in my opinion, are still too high and optimistic. Also, our government is playing a very active role these days in trying to manipulate asset prices, including stock prices. In fact, their actions seem to be governed more by the stock market than anything else.

So stocks are encountering resistance in going down to more sustainable levels. The more sustainable level for the DOW (DJI) is around 6800, given that it was the level before two recent bubbles (internet and the current financial innovation bubble). That was the level governed more by fundamentals and economic growth. For S&P (SPX), a similar level would be around 700 level. Comparing these levels with current values clearly shows that stocks still have further down to go before we reach a bottom. We can reach these levels faster, but given the constant government intervention in proper functioning of markets, we might have to wait 6 months before we reach these levels. But one thing is very clear: Stocks still have to come down in prices further.

My assumptions are that moves from the Federal Reserve and the US Treasury won't backfire. though there is a high probability of that. If current moves backfire and result in decimation of the US dollar and US Treasury bond sell-offs, then we shall be looking at another bubble in the current US Treasury bond market and above sustainable levels will be broken in downward direction. But let's hope that the Fed and Treasury will be as active in sucking out the excess as they have been in pumping it in.

So, my advice to investors: Don't get carried away by looking at stock prices and comparing them with their one year chart. Most stocks are still too expensive, coupled with the fact that the economy is not expected to stabilize until late 2009 or the beginning of 2010. And even when it recovers, it won't look the same as it did in 2006 or 2007. Credit will be expensive and house prices will be at least 20% lower than they are now. So value investors should stay away equities currently. I see more value in corporate bonds these days. If you are careful in picking companies with good balance sheets, you can still get a 7-8% yield in corporate bonds. Even some municipal bonds are attractive. But getting into equities at current levels is riskier. It would be prudent to wait some more.

Disclosure: no positions

Comments

[NOITSNOT:]

So from your perspective, what valuation multiple you think the market should be at to jump back into the stocks?. Right now there are NUMEROUS companies trading at < 10x FORWARD P/E. Under my view, those are already quite fairly valued or even undervalued to reflect current times and the next 6-12 months.

2008 Dec 05 08:46 AM

[Fabien Hug:]

When is a question you can't answer. I think the author has a point particularly when he refers to market price BEFORE the great expansion.
There is a strong "probability" that we'll touch this level before things go better. The big unknown is the effect of government interventions. Without them we would be much lower than the irrational exuberance level of 1996.
Now the truth is certainly in between and I personally I think we reach levels where we can start to progressively reenter the market with 15-20% increments of cash available.

2008 Dec 05 09:41 AM

[patio:]

Or gold.

2008 Dec 05 12:26 PM

[Tacitus:]

I believe the bottom is in, but even if you prove correct and the real bottom is at 6800, that's only 700 below the bottom set on November 21 (Dow) or 50 below the bottom on the S&P. Meanwhile, there are excellent companies with hard assets (i.e., not solely financial assets subject to writedowns) selling for one-fifth or less of book value. The downside risk on these companies is negligible, even if the market drops to 6800 Dow or 700 S&P. At least as to companies like these, it's hard to make a very persuasive argument not to buy now.

Moreover, if the government is pumping in 3 trillion and you believe (as I do) that the stimulus is working, why do you feel the real bottom is at 6800? As the stimulus is seen to be working, where is the justification for the market turning substantially south? So far, the market has been discounting bad news and moving determinedly upwards. The only down days have come in response to multiple up days and thus look like corrections in an overall upswing. In addition, many important indices are at unsustainably low levels and simply have no more downside room. The BDI is down to 660 from highs in the 14,000 range. Shipping will simply come to a halt if that doesn't spring back some soon, and that's not in anyone's interest. Credit, which caused the BDI to crash, is already showing signs of loosening up. Mortgage brokers and bankers are already working around the clock on new loans and refinances. We are certainly not out of the woods yet, but the ice floes that have stalled credit are started to break up.

I agree that 15,000 was overpriced and we are not likely to see that number again any time soon, but it wouldn't surprise me if we get back as far as 10-11,000, and maybe even 12,000, some time next year, before things start heading south or at least sideways again.

2008 Dec 05 08:38 PM

[Old Trader:]

NOITSNOT;

The preferred metric for value investors in judging a stock's "value" is 10 yrs TRAILING earnings. Given the rate at which analysts are cutting earnings estimates (to say nothing of mgmts. cutting/eliminating forward guidance) going forward, I'd trust any forward PE about as far as I can throw a grand piano.

2008 Dec 06 12:02 AM