US stocks only fair value, heading lower
Posted on 29 November 2008 with no comments from readers
US stocks might have bounced off their lows but have only retreated to the fair value levels of 1991. Typically stock markets tend to over-correct, so we are not at the bottom yet, though it might not be that far away now.
Warren Buffett’s mentor Benjamin Graham looked at stock prices against their 10-year average earnings per share to gauge value. On that reckoning stock prices are only sightly cheaper than their long-term average for the first time since 1991. Stocks have been overvalued for a long time.
Down trend
Could a long period of sub-average valuations follow for stocks? Perhaps but we clearly still have to find a bottom in stock prices first. They always over-correct on the way down, a reverse of the irrational exuberance of the upside.
How long will that take? The most optimistic point to the spring next year but increasingly experts suggest the middle of next year might be the time to buy, presumably after people sell in May and go away.
To support the Graham analysis you can also turn to the q-theory. This considers the market capitalization of a company compared to the net worth of its assets. But again we sadly only arrive at the fair value position, and there is no buying signal.
Sell, sell, sell
In short, at this stage any rallies in stock markets should be seen as selling opportunities, if by mischance you still have US equity investments – and by implication most global stock markets will also follow this trend so lighten up there as well.
This column posited 7,000 on the Dow and 3,300 for the FTSE at the start of the autumn, and we nearly got there. It looks like 2009 will see even lower index numbers, and even then it is going to be hard to call a true bottom recalling the 1930-32 down wave (see graph).
How far US economic policy will offset the depressionary forces in place is the big call for 2009. But it is notable that at least economic policy is different this time. Whether it will work is another thing.
Could gold and silver stocks be the exception to this down wave? That was the experience of the 1930s and a coming dollar collapse would likely be the backdrop for a repeat performance by the precious metals sector.
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no Comments posted by readers:
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Cash in on the precious metal
Experts have always said gold is a hedge against inflation, and just as importantly in the UAE, a hedge against the US dollar, which has been particularly volatile this year. With further interest rate cuts expected, it may still lose, thus investors will continue to be wary.
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due a near term rally
but the macro says stocks due much lower still
gold and silver are what to hold long, for the long term
kindly
persistently check http://www.shortorlong.com/ to develop understanding & perception of the markets
From:
Duncan Robertson
Isle of Skye
tel 01471 833 313
Its good to hold a long term position of gold/silver but for small investors the return will only be on paper and will find it hard to sell since its safer to keep gold. Shares generally pay dividends and thats why its hard to advise small investors to put all/most of their nest egg in precious metals. In certain markets (certainly not NOW in Dubai) I think real estate is the best hedge against inflation for small investors since it could result in some positive cashflow.
Dec. 10 (Bloomberg) — A global stock slump may have further to go, according to Tobin’s Q ratio, which compares the market value of companies to the cost of their constituent parts, CLSA Ltd. strategist Russell Napier said.
The ratio, developed in 1969 by Nobel Prize-winning economist James Tobin, indicates the Standard & Poor’s 500 Index is still too expensive relative to the cost of replacing assets, said Napier. While the 39 percent drop in the S&P this year pushed equity prices below replacement cost, history suggests the ratio must sink further as deflation sets in, he said. The S&P may plunge another 55 percent to a trough of 400 by 2014, the strategist said.
“Things have always looked absolutely terrible at the bottom,” said Napier, Institutional Investor’s top-ranked Asia strategist from 1997-1999. With deflation “the value of assets falls and the value of debt stays up, then equity gets crushed. The results are always horrific.”
Shares have fallen this year as the worst financial crisis since the Great Depression caused almost $1 trillion of losses at institutions around the globe and dragged the world’s largest economies into recession. The MSCI World Index has tumbled 44 percent in 2008, set for the biggest annual decline in its four- decade history.
Bear-Market Scholar
Napier, who teaches at Edinburgh Business School, based his S&P 500 forecast on the Q for U.S. equities as well as the 10- year cyclically adjusted price-to-earnings ratio, another measure of long-term value.
Before the trough in 2014, investors are likely to see a so-called bear market rally for the next two years as central bank actions delay the onset of deflation, he said.
The Q ratio on U.S. equities has dropped to 0.7 from a peak of 2.9 in 1999, and reaching 0.3 has always signaled the end of a bear market, said Napier, the author of “Anatomy of the Bear,” a study of how business cycles change course. The Q ratio for U.S. equities has fluctuated between 0.3 and 3 in the past 130 years.
When the gauge is more than one, it indicates the market is overvaluing company assets, while a Q ratio of less than one signifies shares are undervalued because it is cheaper to buy companies than to build them from the ground up.
At the end of the four largest U.S. bear markets in 1921, 1932, 1949 and 1982, the Q ratio fell to 0.3 or lower, and history is likely to repeat, said Napier. From the 1982 trough, the S&P 500 grew more than 14-fold to the middle of 2000, when Napier says the last bull market ended.
Quantitative Easing
Measures such as Tobin’s Q ratio and a 10-year price-to- earnings ratio are “valuable tools,” said Andrew Milligan, the Edinburgh-based head of global strategy at Standard Life Investments, which oversees about $190 billion. Milligan said he is bullish on U.S. equities for now as central bank efforts to fight deflation will push the market higher.
“For those who are worried about losing much of their investment almost overnight, very clearly you’d want to wait for those signals to give a much stronger case,” he said. The bear market will have “a painful resolution, it’s just a question of how painful, over what period of time and for what parties.”
Federal Reserve Chairman Ben S. Bernanke’s indication that he will use “quantitative easing” to prevent deflation points to a stock market rally that may last for the next two years, Napier said. With quantitative easing, a tool pioneered by the Bank of Japan, central banks can stimulate inflation by printing money and flooding the market with cash in order to encourage consumers to spend.
The government’s efforts will eventually fail as ballooning government debt devalues the dollar, causes investors to flee U.S. assets and takes the S&P 500 to its eventual bottom in 2014, Napier said.
“Bear markets always end for exactly the same reason, and that is the market begins to price in deflation,” he said. “Equities will be incredibly cheap.”