Time To Buy?

Since the October 9th low, the Standard & Poor Index of 500 Stocks, representing the bulk of stock wealth in this country, has risen 22%. Brokerage firms have declared that the stock market recovery has begun and that the time to buy is now or we will “miss the market”.

Wait a minute. The market had a 21% recovery from the September 21st, 2001 low and a 21% recovery from the July 24th 2002 low, during which brokerage firms, each time, declared that lows had been reached and that a new bull market had begun. Those investors who believed in a new recovery lost substantial amounts of their capital. It is probable that investors who return to the market at this time will be severely shocked when the market resumes its move to reasonable levels of value.

Why?

223 of the1757 hedge funds have folded this year, meaning 13% of all hedge funds have gone out of business through October 31st. In 2001, 5% of the hedge funds went out of business, and in 2000, 1.6% of hedge funds went out of business.

Interest rates are at an all time low in our lifetimes, but borrowing by companies who make consumer durables, borrowing by companies who build homes, and borrowing for business capital spending have been unresponsive to low interest rates.

The “real growth” of this economy is 1.6%. High school and college graduates coming into the labor force looking for jobs will not be able to find jobs unless real growth exceeds 2%. And in an economy with already high unemployment, the growth absorption for labor would require more than 2%. With high unemployment, and an increasing pool of labor, the demand for labor is less than the supply, and the price of labor (wages) must therefore go down. When the price of labor goes down, there is less cash flow, specifically disposable income, for the entire economy. And remember: consumer spending comprises 2/3 of our GDP!

The Standard & Poor Index of 500 Stocks is selling at 33 times earnings per share and yielding a measly 1.8%. Once the new accounting rules are enforced to account for options and warrants outstanding, the Standard & Poor Index of 500 Stocks will be selling, based upon the current trailing 12 months earnings, at about 50 times earnings. Where is the value in a market selling at 50 times earnings when average historical price earnings ratios are less than 15? Where is the value in a market yielding 1.8% when historically the Standard & Poor Index has yielded more than 4% on stocks?

We really only need to know two things about the market in order to make investments:
What are the relative values in the market? The above points out there are no values and the market is horribly overpriced.

What is the direction of the economy, and what is the primary trend of the stock markets? In spite of all the huff and puff by the government and the Federal Reserve and the brokerage firms, the direction of the economy, at best, is neutral, not up, and in most segments, the direction of the economy is stinko. The world’s economies depend upon the US economy. The rest of the world is in recession. With continued cuts in cash flow in the US, the hope for recovery in the rest of the world’s economies is poor, indeed.

Is There A Saving Grace?

Let’s try to look at the big picture and see if there are reasons the market might be able to sustain these levels, and trade in this range, or even increase from these levels.

Foreigners own 40% of treasury securities and 24% of our corporate bonds. In total it is believed that foreigners own 8.2 trillion dollars of our assets, roughly 25% of US wealth. This provides an opportunity for the rest of the world to fight like mad to keep the value of the dollar up which, while the dollar is down for the year, is probably why the dollar has been strong over the last few weeks.

More than 70% of the world’s central bank reserves are in dollars. This provides another tremendous force against the dollar going down much more in value. If the dollar continues to go down in value, the central banks of the world are actually losing the value of their currency reserves.

With all the problems in our economy, and around the world, why is the dollar holding its value? The answer is simple: even though the dollar has been weak and its purchasing power has been reduced substantially in our lifetimes, other currencies are worse. As badly as our central government is managed, and in spite of dollars wasted, our government is the best managed of any of the large governments in the world.

The appetite for US dollars around the globe is huge. American trade deficits on a daily basis exceed 1.1 billion dollars. Should we stop buying more foreign goods than foreigners purchase from us, already high unemployment throughout the world will become higher. Foreign politicians, therefore, continue to encourage an influx of US dollars and the matriculation of those dollars into their own economies.

Summary

While the above is not a happy scenario, it does point out there is a balance between the weakness and the power of the US economy, and our influence, both at home and throughout the world. It’s sorry to admit our government is the lesser of evils as far as other governments in the world are concerned. It is disheartening to realize the direction in which we are headed is that of Japan and European economies, both of which are over taxed and dominated by big, inefficient, confiscatory and overbearing central governments. But that’s the direction in which we are headed. And just because of the shear power and might of this economy, and the rest of the world’s dependence upon this economy, we may “muddle through” for the next three to six years.
John Mauldin (www.2000wave.com) coined the phrase “muddle through economy”. He writes a free weekly newsletter that is extremely informative and highly recommended for people interested in the stock market. His theory, in concert with many other economic thinkers who focus upon value, and not hype, concludes that the frustrations of unemployment, manufacturing moving offshore, continued personal and corporate bankruptcy, high debt service and burgeoning government debt, dictates this economy, at best, will “muddle through” for the next several years. Until the structural problems that exist have been addressed and brought into balance, where is the hope for an expanding and vibrant economy?

The odds of the stock market continuing to obtain significantly higher levels from its current position are much less than the odds of our markets testing the lows of a few months ago. Stock purchases in this market’s trading range are dangerous. Avoiding this market will help assure one of a happy holiday season.

Caveat Emptor!
George Rauch
December 6, 2002

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