"Be fearful when others are greedy, and be greedy when others are fearful." -- Warren Buffett
"Hold my beer and watch this." -- Old joke about a redneck's last words
Looking at the broader market -- off 10% in ten trading days -- I keep coming back to these two quotes as I consider taking some cash off the sidelines and putting into the market. The famous quote from the "Oracle of Omaha" rings true as I look at some of the valuations in the market: Walmart (WMT) at a forward P/E of 10 and a yield above the 10-year Treasury; Intel (INTC) yielding over 4 percent; Microsoft (MSFT) with a forward P/E just above 8! Apple (AAPL) grew sales 75% yoy last quarter, from $16 billion to $28 billion, a simply astounding feat from a revenue base that large. Its forward P/E is now under 12 after a nearly 7% haircut the past two weeks. A quick look at famous stocks seems to show bargains everywhere on high-quality American companies. Perhaps it is time to be greedy among the fearful.
Of course, as I actually ponder putting some hard-earned cash into US equities (or, more accurately, clicking my mouse a few dozen times to move my electronic imprints from one account to another), I start to feel a bit like the redneck. For one, I am drinking heavily -- one look at the 10-day chart for the S&P 500 will do that to a man. "Are you nuts?" I think. "Of course the P/E's are low -- the world is ending and no one will make any money! The market bulls are talking about growth coming from the BRICs. We're relying on Russia and China, for God's sake! Invest in cases of beer, ammo, and whiskey, and waste the rest."
And, let's be honest, the fears are well-founded. There are political risks, economic risks, and currency risks everywhere a US investor looks. Diversification seems near impossible, as the correlation of asset classes through the "risk-on trade" seems almost uniform (on Thursday, the US equity market sold off in a panic and gold...dropped half a percent.) Investors are literally chasing yield around the world, to little success. The risk/reward profile for many investing classes seems unappetizing, at best.
All that said, there are reasons for optimism here in the US stock market. The comment I heard a few times over the past few days, online and off, is something to the effect of: "Of course the market's crashing! We were back near 2007 levels in the midst of a worldwide recession!" But we have good reason to be near those levels: corporate earnings are up. In fact, in the fourth quarter of 2010, they hit an all-time high. In 2010, the S&P 500 earned $83.77 per share, slightly better than the 2007 levels. (All earnings data post-2008 from S&P; links to spreadsheets here. Pre-2008 data can be found here.) The market closed 2007 at 1468.36; Friday's close of 1199 is 18.3% below those levels. 2011 earnings are estimated to near $100 a share; and while those estimates have been criticized elsewhere, bear in mind that 274 of 384 S&P 500 companies (some 71%) who had reported before this week beat earnings estimates. S&P's Howard Silverblatt sees a strong second half, noting, "At this point earnings are the main support beam for the market, and they are doing very well."
While analysts can certainly be criticized for the failure to update year-end profit estimates, 2nd quarter sales for the S&P 500 are projected to rise 10% year-over-year. Margins are up. With margins and sales up, 15-20% earnings growth on an index-wide basis hardly seems unattainable. Even if the index misses year-end targets, it should safely see 8-10% growth, a minimum of $90 for the index as a whole, for a current earnings yield at about 7.5%, above historical averages.
It is true that the economic picture doesn't look pretty, but the dirty secret of this economy is that it is not all that bad for corporate America, particularly those who are industry leaders and/or have the advantages of economies of scale. Productivity was up 3.7% in 2009 and 3.9% in 2010, compared to 1.0% in 2008, according to the Bureau of Labor Statistics. Larger companies have shown the ability to squeeze more out of employees and suppliers; low interest rates have not only lowered interest costs but allowed for re-financing of debt and prepayment of principal. Indeed, corporate balance sheets are stronger than ever, as corporate cash balances continue to set records. Those strong balance sheets, the preservation of capital, and the focus on cost-cutting may not be good for the economy at large, but they can be very good for the underlying stocks. And bear in mind that the US economy is not the sole driver of the stock market; in 2010, 46.3% of sales for the S&P 500 came from overseas. A recession like this, which is confined largely to the lower- and middle-classes, is an economic and political disaster. It need not be for the stock market at large.
I don't pretend to predict the future, or a 20% gain in the broader indices before year's end. Nor do I believe some of the doomsday scenarios for the market. Investors should expect swings, more dips, and perhaps a continuation of this correction next week. But for long-term investors, there are bargains to be had. Larger tech names like Intel, Cisco, Apple, and Microsoft trade between 10 and 12 times earnings, or less. Semiconductor stocks -- off 20% in three months -- may offer value, with companies such as Brooks Automation (BRKS), Entropic (ENTR), and Kulicke & Soffa (KLIC) trading at enterprise value-to-earnings ratios below 3. Quality companies like ConocoPhillips (COP), Kimberly-Clark (KMB), Raytheon (RTN) offer dividend yields north of 4%, well ahead of the 10-year Treasury bond. Even the SPY index fund, now offering an expected earning yield over 7%, and a dividend yield over 2%, is offering returns on the high side of recent ranges. (Please note that none of these are solid recommendations, simply data points on some of the valuations currently available in the US equity market.)
In short, long-term investors who have the stomach for it can find opportunities in this market. I hope to be one of them; I just need to find someone to hold my beer.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.