“All is well.”
Investors are being told that they have a great opportunity before them – because, the market has ‘bottomed out,’ and stocks are the cheapest they’ve been for 12 years.
As to the first proposition, they point to the stock indices. And it is true, after falling nearly 10% after July 19th, the indices seemed to find their feet in August… and have been gaining ground ever since. Of course, if our memory is correct, this is not the first time the stock market was shaken in the summer. It happened in the late ’20s too. And then, investors recovered their nerves, stocks rose… and later collapsed in the fall.
Optimistic voices continued to say that the tumble was very temporary… and that these lower prices created a great buying opportunity. But stocks sank… and sank… and sank… and didn’t return to their ’29 high until the 1950s!
Yesterday, the Dow fell 143 points. The day before, it went up. Which direction will it go tomorrow? If we only knew!
Also, the dollar is down this morning, against most major currencies… but guess what’s up? Our favorite precious metal…
“Warren Buffett, investor extraordinaire, offers two ways for you to protect your purchasing power against a weakening dollar,” our friend Chris Mayer tells us. “The first is your own earnings power. The second is ownership in a wonderful business, which an individual investor can get by holding onto great stocks. A stock is, after all, a share of ownership in a business.”
Which brings us back to the second proposition – that stocks are cheap – deserves more comment. Stock prices, generally, are about where they were eight years ago. For all his risk and trouble, the average stock market investor has almost certainly lost money – after commissions and inflation – over that period. Still, corporate earnings have gone up – for the various reasons we have discussed in these reckonings.
Without once again examining the unreliable and perverse nature of these increased earnings, we merely note that higher margins may be a good reason to pay more for a single company, but not for an entire market. In a single company, higher margins may reflect efficiency, good management, or a near-monopoly franchise.
“While I have nothing against owning gold or silver – in fact, I think it’s good to own some – it’s also helpful to think about solving the problem of dollar erosion more creatively,” continues Chris. “In the stock market, you can own many great companies with valuable tangible assets that will probably be worth much more in the future than today.”
But when looking at the entire market, not just a single company, high margins are always followed by low margins. Competition, increased output, and higher costs inevitably reduce the gap between revenue and expenses.
The news is full of encouraging words about how stocks on the S&P are the cheapest – in P/E terms – they’ve been since ’95. Still, they are trading at nearly 17 times earnings. That may be relatively cheap… but it’s not absolutely cheap. At genuine market bottoms stocks sell for as little as eight… or even five… times earnings. We have a long way to go before we get there. And getting there will be especially painful, because margins will fall along with prices. In the coming slump, companies will have lower sales… and lower margins. As the denominator of the P/E ratio falls… the nominator will have to fall even more to keep up with it.
Not that we know what direction stocks will go in the near term. Even Richard Russell thinks we are in a bull market that will carry prices considerably higher before the collapse comes. Maybe he is right. But anyone who buys stocks because he thinks we are at a real ‘bottom’… or that stocks are ‘cheap’… probably works on Wall Street.
Markets and Money