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moneysense.ca, 17/03/09
Bear Market Valuation Indicators?
In media interviews, Derek Foster justifies getting out of stocks based on “doing lots of research” on certain indicators. We’ll take a look at them in this post.
Valuations were lower when the stock markets crashed in the 1930s and later in 1973 to 1974, he points out. The dividend yield on the Dow Jones industrial average fell to 6 per cent before, but is at 4 per cent today. The price-to-earnings ratio of stocks fell to the single-digit range before, but is still in double digits now.
Valuations are an inexact science and applying past trough P/E ratios to today’s trough earnings may not be appropriate. The Peridot Capitalist points out that in 1974, the S&P 500 had a P/E of 7 but earnings were at record highs for the time. I’ve never heard of the dividend yield on the Dow being an indicator but the yield on the Dow has been low for a long time now.
The total market value of stocks fell to 50 per cent of the gross domestic product before, but is at 70 per cent today.
It is true that stock market capitalization to GDP has been lower before but this article points out that the current valuation are at the 70th percentile when looking at past recessions. In other words, it might get better from here, or worse, who knows?
It is almost impossible to figure out short-term stock market moves and smart investors don’t even try. Derek could try and sound smart by quoting a bunch of metrics but what I see is simply another retail investor throwing in the towel.
moneysense.ca, 17/03/09
In a collapsing earnings environment, it drives me crazy to hear people saying that stocks are cheap on a trailing P/E basis. The problem is that in the next quarter, the earnings could very well be a negative number! I hold quite a few stocks in the USA which now have a very negative P/E ratio, thank you very much! And the stock price is down 98% and they have completely cut distributions to 0%. Does this mean that it’s a screaming bargain? Not in my opinion – it deserves to be in the doghouse.
Phil: I agree that some companies are not cheap at all based on this metric (i.e. AIG) but like i said before depending on the company if you look at normal earning power than there are some cheap valuations out there.
Companies like Coca-Cola or Canadian Banks or Diageo or many others who have taken a huge beating over short term earnings are cheap. If you are a long term investor and hold them through recession when earnings go back to “normal” this can be seen as cheap. Getting Canadian banks in single digit P/E and 5% yield this is very cheap to me.
need the ‘margin of safety’ in this market. Good long term prospects, good management, minimal leverage, high ROE, etc.
I don’t blame him for pushing his book but his hypocrisy in timing the market based on supposed research is counter to his writing.
He’s more a personal finance sucess story than a investment guru. What he espouses is information readily known in other books or freely on the web.
Phil: Actually, trailing p/e is now very high — around 30 because earnings has just collapsed to around $27, compared to $84 at the peak of the cycle. I don’t know where the ‘p/e is around 11′ claim comes from; probably it is forward p/e and not trailing p/e.
Wouldn’t the market capitalisation issue also be influenced by the share of incorporated and publicly-traded companies relative to unincorporated and non-publicly-traded companies? Does the US economy have more publicly-traded companies that constitute a larger ratio of market cap to GDP now than in the 1970′s?
I hope we don’t reach those historic lows. The market is based on confidence. I believe there is a lack of confidence in our government at this time. We need to get back to the basics.
Can’t wait to hear if Derek gets back into the market at the right time or if he misses the rebound completely. I’m guessing he’ll miss. Then again I’m sure he’ll have some kind of excuse justifying why he didn’t really miss blah blah blah…
CC, just wanted to say thank you for your continued rational posts. As the financial press is all doom and gloom these days, it’s kind of terrifying as I invest my family’s money. Posts like these help me keep a clear head and weather the storm!
CC: what a great blog! Thank you for sharing the knowledge with me and the world.
I like how you respond to questions so quickly as well. I have nothing to suggest for improvement.
However, I noticed that you have an issue with Derek Foster. He must have done something right to retire at 34. I understand you may not agree with his style. I just found your follow-ups and the comments on him a bit bashful. After reading his first book I discovered the investment world and his ideas helped free myself from under the mutual fund bondage.
I just don’t think the sheer volume of focus on Mr. Foster has been that fair of late on your blog.
Otherwise, I love your blog and will continue to visit. Thanks and keep up the good work.
Ed
Ed: I’m curious. Which comment do you find bashful?
As a matter of fact, I have a huge issue with Derek Foster’s latest move of selling out of his entire portfolio and using it for getting publicity for his new book. I haven’t yet read the new book but apparently he now advocates option strategies that are frankly very risky for retail investors. I don’t know why he should get a free pass when tough questions need to be asked.
A wise investor once told me that investors spend too much time in the past and not enough thinking about the future.
As an investor you make your own future based on your decisions. Looking forward rather than in the rearview mirror might be something others want to consider in this current environment
Ed: Just wanted to respond to your earlier comment about Derek Foster: “He must have done something right to retire at 34.”
Many of us are of the opinion that Mr. Foster was fortunate in his timing and selection of a few select stocks, but that his good fortune is nearly impossible for the average investor to replicate. It could be likened to a thousand individuals buying lottery tickets and one of them winning. Would we think that the one winner who became instantly rich was doing the right thing or was just lucky?
The concern that CC and many others have, including myself, is that Mr. Foster’s advice may be hazardous to the financial health of the average investor who simply adopts his strategy without due diligence.
I don’t think that CC or others are intending this critique of Mr. Foster’s strategy as a personal attack, but instead as a way to prompt investors to question and get more information about the strategy before those investors engage in it themselves.