July Worst Month For US Stocks in 3 Years; Why Stocks Are Always Risky

Dow 14,000…we barely knew ye.

Yesterday, the Dow headed down again…losing 146 points. This follows a few days last week when it went down 580 points…making July the worst month for U.S. stocks in three years.

But now, we’re in a new month. Stocks are dropping. Will they continue to drop?

Oh…dear reader…you know better than to ask us that. If we knew the answer we’d be borrowing millions in yen in order to speculate. Heck, we’d start our own hedge fund and charge 2 & 20…no, 3 & 30. We might even be tempted to charge for Markets and Money!

But no, we continue to offer these humble insights and reflection at the price they deserve. Because, alas, we are mortal too – just like you. And it is not given to man to know his fate…or the fate of his Dow Jones Industrials.

Besides, it doesn’t matter to us whether stocks go up or down. We’re not speculators. We’re moral philosophers and kibitzers. We believe you never get what you hope to get…nor even what you expect to get. You get what you deserve. And even if you don’t get it, you ought to. And you ought to believe you will get it.

In the words of Doug Casey, who was a speaker at last week’s Agora Financial Investment Symposium, “Whatever is going to happen will happen…just don’t let it happen to you.”

In other words – position yourself in a way that you are protected from whatever is around the bend.

So, what is this drop? The beginning of a correction? The end of a bull market? The end of a rally in a bear market?

Over the long run, investors have judged stocks to be worth about 20 times earnings, on the high side…and about five times earnings on the low. This implies an earnings yield between 5% on the low side, and 20% on the high side. People have traditionally wanted yields (or, implied yields…investors don’t normally receive 100% of a company’s earnings in dividends) from stocks higher than what they would get from bonds or from current accounts. Why? Because stocks are inherently risky. Most people nowadays would say that they are inherently “volatile” but that’s not the same thing.

Volatility is a type of risk. Stock prices go up and down, depending on what mood the voters are in. Sometimes they are fearful and won’t pay more than 5 to 10 times earnings. Sometimes, they are greedy and hopeful…willing to pay 20 times – and more – for a stock (because they think it will go up). This movement in prices makes stocks unreliable. If you need to pay your child’s college tuition and the stock market has just corrected 30%…it is small comfort to know that in 5…10…or 20 years stock prices might be back to where you got in. In the past, investors demanded a little extra compensation from stocks to make up for this inconvenience and uncertainty.

But then, after a period in which stocks have been stable and rising, the voters forget about the premium. They begin to think that stocks have been under-priced in the past, because past generations of investors weren’t very smart. They run up stocks to the point where bond yields are actually higher than earnings yields…that is, to the point where the premium for volatility has disappeared. Then, in Mr. Market’s own sweet way, stock prices suddenly go down…and investors wish they hadn’t been so bullish.

There is also risk of another sort – real risk. The real risk is not a feature of the voting machine; it is the harsh judgment of the weighing machine. Sometimes stocks go up. Sometimes they go down. Sometimes they go away.

A stream of interest earnings from a bank…or a bond…or the Treasury is not guaranteed. But it is usually much more sure than a stream of income from a business. In the short run, anything could happen that could affect business earnings. In the long run, everything does. Businesses go bankrupt, lose their competitive edge, miss important innovations, mis-invest, run out of money, are embezzled and mismanaged, become obsolete, and fail. Some fail every day. All fail eventually.

Bill Bonner
Markets and Money

Bill Bonner

Bill Bonner

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America’s most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind Markets and Money.
Bill Bonner

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