Market Watch - July 30, 2005

Time To Invest In Stocks?

No. Not yet. And not for quite a while. T-bills pay 3-1/4%. They’re secure and you get your principle back in 90 days. Bond funds that pay over 6% are ACG, BHK, PTY, PFO, PFD, JQC, EMD, SGL and EDF.

The economy continues to improve. But the stock market remains considerably overvalued. With the smartest economists and money managers at odds on the potential impact of so many economic variables, the smart investor will bide their time, stay liquid in cash or cash equivalents, and wait for the right time to re-commit to the stock market.

Question: Why wait? Aren’t there sectors, like housing, for example, that are always going to be prospering? And don’t we miss these great opportunities if we sit on cash?
Answer: There are always “opportunities” to invest and make money in any market. But who’s smart enough to pick the right opportunities all the time? Warren Buffet thought the dollar would go down substantially more than it has. So he placed a multi-billion dollar bet on a descending dollar, and he’s lost a lot of money. While he’s lost billions on this bet, technically, Buffet’s right: the dollar has no way to go but down over the long term. Just as it has in our lifetime, the purchasing power of the dollar will depreciate. But when, and how fast, is a subject that few experts agree upon, including one of the smartest of all times who is currently learning his lesson the hard way.

Question: Aren’t corporate profits up? And isn’t the Federal Budget Deficit coming down? And isn’t this a good sign?
Answer: Yes, yes and yes. But unanswered questions point out potential future economic turmoil that will negatively effect stocks: inflation or deflation; increasing or decreasing interest rates; real estate overpriced or not; dollar going up or down; are India’s labor rates a threat to Chinese labor or not; is the increasing trade deficit something we should concern ourselves with; are fuel prices going up or down; and is personal debt out of hand and about to seriously hurt the American consumer?

There are elements of economic risk in all of the above, and an adverse reaction in any of them could send the stock market south in a hurry.

Question: How can one hope to make money in the market with all of the above hanging over our economic heads?
Answer: With great difficulty and good luck - lots of luck. Speculation can create profits at any stage of a bear or bull market. But great profits in the stock market are made by purchasing stocks when they are attractively priced.

Professor Jeremy Siegeal of the Wharton School of Business (Siegeal and Wharton are both as good as they come in finance and the markets) wrote in the July 11th issue of Fortune: “The research I did for my latest book made me more of a value investor than before. I verified how important dividends are in boosting long-term returns. And how important reasonable valuations are. You find that a lot of fast growing companies don’t provide the best returns because they are just priced too high.”

Moreover, buying low-dividend, or no-dividend, paying securities when the S & P 500 stocks are selling at over 20 times earnings is almost a guaranteed way to (1) gain nothing and (2) lose capital.

Question: What about real estate, and how about that terrific recent report pointing out that consumer spending is holding in there at 67% of GDP?
Answer: U. S. real estate was valued at $6 trillion in 2001, and the value had exploded to $17 trillion by the beginning of 2005, almost a three fold increase in only a few years. The current real estate bubble is even greater than the stock market bubble of the 1990s. The public got slaughtered in tech stocks from the 1990s run-up of the market. As sure as we’re breathing, history will repeat itself (remember Japan), and the retail public will get slaughtered again in overpriced housing and real estate.

Further, the happy American consumer borrowed $700 billion from their home equity lines last year and spent $108 for every 100 dollars earned. Borrowing for consumer goods, rather than for capital investment, creates future repayment obligations that stifle, rather than fuel, economic expansion. Consumer debt automatically feeds upon itself through compound interest. The $700 billion borrowed by consumers exceeded the value of all pay raises in 2004. Add to that the fact that consumers have had to absorb high increases in fuel prices, and you’re looking at a “day of reckoning” that could literally obliterate the existing world’s monetary economic system.

Question: Can fuel prices continue to increase, and if so, what can America do?
Answer: Fuel prices are regulated by the law of supply and demand. As long as demand increases, and it will, supply must keep up with demand. With environmental regulations and the media and politicians continuing to fuel the fire of fear over our environment, regulations will remain in force that inhibit our ability to produce adequate further resources to meet demand. So fuel prices will remain, and possibly go, high(er) in the next 5 to 10 years.

A really smart way to solve this economic shortage is by switching to different types of fuel - specifically nuclear. Look at the cost per million BTUs for different sources of energy:

And lets assume uranium increases in price by 50 times as demand picks up. NUCLEAR ENERGY COULD STILL BE PRODUCED EQUIVALENT TO BUYING GAS AT 1⁄2 CENT PER GALLON!

Switching to uranium is a no-brainer, but will we? It’s safe, it’s clean, it’s cheap. How many deaths a year from coal mines, gas explosions and oil well mishaps? Lots! And how many from nuclear power? None!

Interestingly, Americans now use only 9,000 BTUs to produce a dollar of GDP as compared to 17,000 in 1974. Where would gas prices be today if we hadn’t made these strides?

Conclusion

Investors in this market need to be aware of the ‘Las Vegas’ syndrome. Rather than think of appreciation first, then income, and finally safety, the retail investor in an overpriced market should reverse their thinking and concentrate upon safety first, then income, and finally capital appreciation.

There’s good growth and bad growth. Good growth is supported by internal income generation and saving. Bad growth is supported by asset bubbles and debt. Until we reverse our current growth model, and until the stock market’s values improve, the market remains positioned to relieve us of more of our hard earned capital.

There are eight leading economic indicators used to measure the vibrancy of our economy. They are now basically neutral, meaning it is difficult to measure potential for further economic advancement. Neutral is better than negative, but “neutral” is not a benchmark for the stock market to leap to new levels.

Caveat Emptor!
George W. Rauch
July 30, 2005