Market Declines Offer Long-Term Buy Opportunities for the Strong of Stomach

The scope of global stock market declines in the past year appears to be offering investors a very attractive long-term buying opportunity, provided they have strong stomachs and an appropriate time horizon. Although we can always hope, investors should not expect immediate gratification from the markets, given the extreme uncertainties in the economic outlook. Moreover, investors should take the opportunity afforded by the recent rebound in markets to reflect on their asset allocations. Unless one is making opportunistic purchases in times of crisis, it is always far better to make needed asset allocation adjustments when markets are relatively calm than in periods of extreme distress.

The ideal response to a 50% drop in the markets in the midst of an all-out panic (which from a contrary opinion standpoint is a buy signal) is to increase one’s risk exposure. Investors who did not do this were either (1) following a passive asset allocation strategy, which didn’t have the tactical flexibility to buy on weakness or (2) didn’t have an asset allocation going into the decline that left them confident enough to buy when bargains presented themselves. The declines experienced in the fall were of a once-in-a-lifetime variety, which stress tested even the most well conceived asset allocations. The most important thing, of course, is not to sell risk assets in the midst of such historic market dislocations.

No one knows what the coming year will bring, but investors can take comfort from the knowledge that stock and corporate bond markets are the most attractively priced in a generation. This knowledge, combined with the discipline to tune out the day to day noise, will help investors ride out whatever storms lie ahead.

U.S. Stock Market Valuations

At the recent lows, U.S. stock market capitalization as a percentage of U.S. GDP reached its lowest level since 1995. Moreover, this valuation measure had fallen approximately 20% below the lows recorded at the end of the last bear market in the first quarter of 2003.

The loss of value in the stock market this decade is even more dramatic when adjusted for inflation. The unfortunate reality is that a unit of the S&P 500 (SPY) buys less in aggregate goods and services in our economy, thanks to inflation, than it did at the start of the decade. When inflation (measured by the CPI) is applied to historical stock values, which is what is done in the chart below, the S&P 500 at 11/30/08 was 17% lower than the trough of the last bear market six years ago and was 61% below the inflation adjusted stock market peak in March 2000.

[click to enlarge]

Comments

[ArtfulDodger:]

Okay J.D., I can see out a long ways and have a lead gut. So what do you recommend buying, sir?

Jan 06 07:57 AM

[Paul Price:]

On a valuation basis this market is extremely cheap.

I'm an enthuiastic buyer of low/no debt companies with positive earnings.

See my articles here on Seeking Alpha for the specific stock names.

Jan 06 08:09 AM