Time to Buy Stocks?

October 23, 2008 by  


By Bob Wood, MMNS

610x

Considering the time that passes between my writing this article and your reading it, you may have new and better information than I had about whether this is a good time to buy stocks. This past week, an article written by Warren Buffett appeared in the New York Times, in which he advocated that this is the time to buy domestic stocks. I couldn’t disagree with him more.

I’m certainly not the first person to disregard the words of the greatest investor of our time. Actually, I have disagreed with him before, though I know that ignoring the advice of such a great investor might prove costly. But as much as we all admire what he’s accomplished over time, I believe that today’s set of facts does not support his current view.

Why do I differ with him regarding his advice to buy domestic market stocks?  First of all, he did not identify which shares he is buying or what sort of special deal he’s negotiating for himself. His earlier arrangements to buy big stakes in Goldman Sachs and G.E. came with unique terms that are not available to the rest of us.
His premise for buying domestic stocks centers around the amount our markets have fallen and the degree of pessimism and fear remaining among investors. And those points give me no case for argument when I review year-to-date returns for many of the best-rated mutual funds. Up to 40% losses are common, even with baskets of stocks managed by professionals!

With that kind of loss from professionals, imagine the hurt felt by many other investors who have been attempting to manage their own savings! Hedge funds have offered some relief, but many of the top-rated hedge funds have suffered through a terrible year too. So, yes, investor anguish is pervasive, making Buffett’s basic premise seem valid on the front end.

But I have an alternative premise of my own for you to consider. Until our domestic housing and job markets show signs of life, I see little hope for rising corporate profits that could begin to justify current average valuations, such as the 18-times-earnings number quoted for the S&P 500.

As you know, several financial firms have recorded heavy losses, and some have gone bust. Yet others are still alive. Look at the massive hits taken during the third quarter and in the past few quarters by survivors like Citigroup and Merrill Lynch. Once they’ve cleaned up the mess they’ve made of themselves, profits could return, thus helping to lower the average P/E of stocks in the S&P 500 index.

But we can also expect falling profits in the energy sector, affected by the stunning drop in the price of oil over the past year. And with the U.S. economy undoubtedly in recession, any hope for rising profits appears to be strained, at best. So, you may argue, none of my points assure that we won’t see a rally at some point, quite possibly a strong one, like the 900-point Dow rally of last Monday, October 13.

That’s always possible. However, I still see our markets in the midst of a secular bear market, one that could last, potentially, for another 10 years. Of course, stocks might also crash to an average valuation normally seen at the onset of a new, long-lasting bull market, which would mean an average P/E of 10 or less. If that were to happen, I’d certainly go shopping in the domestic markets, too!

Imagine the S&P 500 selling at about 500 vs. today’s 940 mark. Or think of the Dow sitting at about 6,000. At that point, I’d have to admit to the availability of bargains galore. But we’re not there yet, and the underlying fundamentals do not support brisk economic activity any time soon.

However, other markets are selling at depressed valuations, and, there, bargains are to be found. Surely, it comes as no surprise to long-time readers of this page that I have long seen such opportunities in foreign markets.

Anytime we can find markets that are selling, on average, for single-digit earnings multiples and showing underlying fundamentals much better than any found domestically, we should be tempted to look there. That’s where I have been looking — and buying incrementally — in some of those markets with better valuations.

As someone who has long watched and advocated foreign markets as better alternatives to our own, I have been frankly surprised at how far those markets have fallen. But due to hedging my clients’ long-side exposure, I have been able to avoid the worst of the damage, and holding shares in an emerging markets inverse index fund has also cushioned the blow.

While our S&P 500 now sports a loss of about 36%, as of this writing, some of the more reasonably priced international markets have fallen much more. For example, the German market is down by 41%, while Japan’s already depressed market is off by 43%. Brazil, one of my favorites, has fallen by 43%; India, 51%; and China, 63%. The Russian market has been pummeled, now down a whopping 71% from its recent peak.

Did I hear someone say: “Clean up needed on aisle five”?

After witnessing those punishing falls in international markets, exacerbated, (as we hear reported) by hedge funds that had invested in them using too much leverage, we’ve seen our own mutual funds suffer from a constant stream of redemption requests. These came from those same investors who couldn’t wait to plow money into those funds the previous year, as they chased performance once again.

If we look at the good side of all this bad news, we see that we can now go shopping in depressed markets where underlying economic fundamentals look much better than our own. For example, Brazil’s market (as quoted in the Financial Times) is selling at an average P/E of 10. Russia’s market is selling at an average P/E of 6; Singapore’s market, sells at 6, as well. Stocks in Thailand and Turkey sell at about 7 times earnings, on average, while China’s market sports an 11 P/E. In Norway, the average valuation is about 5!

And there are others, too. But the domestic market is still priced for all that Goldilocks nonsense we heard so much about earlier this year from promoters in the financial media. Of course, the global credit crunch is “for real” and doing incredible damage everywhere. And, yes, risks still exist for investing in places like Russia, China and Brazil.

But with the valuations we’re seeing, I think that recession has already factored into those share prices. Massive leverage is coming out of the system, and forced selling in those smaller markets has taken its heavy toll on those shares.

We investors all know that when the valuations are right, we should buy low and sell high. Yet it’s not easy to do that when those amazingly low valuations come only when overall market prospects look darkest. But you can be smart about this. Pay attention to the size of your allocations in each market or stock you select, and know that volatility is here with us for the foreseeable future.

These are good times for careful, patient investors, who understand that opportunities like this only come along once in a decade, or maybe just once in a generation. But proceed with caution!

Have a great week.
Bob

Bob Wood ChFC, CLU Yusuf Kadiwala. Registered Investment Advisors, KMA, Inc., invest@muslimobserver.com.

10-44

Comments

Feel free to leave a comment...
and oh, if you want a pic to show with your comment, go get a gravatar!