Market Watch - September 12, 2008
Nobody knows! Over a period of time, however, the market will go up dramatically from current levels. At this point in time, however, there is more volatility in the market than ever before. Volatility implies uncertainty, so the language of the market is telling us that there is a huge amount of uncertainty. Yet the market refuses to either go down substantially, or to increase in value substantially, which reminds us of the old Wall Street adage that “the market always does what it is supposed to do, just never when we expect it to!” So rather than trying to figure out what is going to happen in the next three to six months, let’s concentrate upon two things: what the market can be expected to do long term and what opportunities may exist in the market at this moment, if any?
Global Dynamics of Wealth and the Market
World wealth is estimated at $125 trillion (Professor Edward Wolff of NYU), and U. S. assets are estimated to be a whopping $52 trillion or 42% of the world’s wealth. Those are staggering numbers. Additionally, total U. S. stock market share values are about $15 trillion or 12% of the world’s total wealth. These dynamics assure investor’s future interests in U. S. markets will continue to be tremendous. Demand for ownership of U. S. securities alone is enough to reasonably assume, that over the next 10-20 years, our markets will probably again lead the world in price appreciation. There is just no concentration of economic power available anywhere in the world like the giant U. S. corporations. They do have competition, and the competition is tough; however, U. S. companies are generally able to meet, and beat, the competition.
There is a lot of competition for U. S. assets. A United Nations study headed by Duncan Green shows that the richest 10% of adults in the world accounted for 85% of the world’s total global assets, and that half the world’s population owned only 1% of global wealth. Green says that “These levels of inequality are gross. It is impossible to justify such vast wealth when 800 million people go to bed hungry every night. The good news is that redistribution would only have to be relatively small. Such are the vast assets of the rich, that it’s nothing for them to be giving up a small part of their wealth to transform the lives of millions”. These thoughts lead the cry for additional taxation to re-distribute America’s wealth “for the good of all of us”.
Doctor Madsen Pirie of the Adam Smith Institute disagrees with Dr. Green and says “The implicit assumption behind this is that there is a supply of wealth in the world and some people in the world have too much of that supply. In fact, wealth is dynamic. It is constantly created. We should not be asking who in the past has created wealth and how we can get it off of them.” Ruth Lea, the director of the Center for Policy Studies, says that although she supports the goal of making poverty history, she does not think that increasing aid to poor countries is the answer. She goes on to say “It’s no use throwing lots of aid at countries that are basically dysfunctional”.
For example, let’s look at the United States who, after 40 years, has basically spent about $40 trillion in an effort to reduce poverty. Has it worked? It has not. It has instead created an economic underclass that has learned to live off of the welfare state. Their incentive, and their children’s incentive, is to learn how to use the system to provide support for them rather than working. Work is exactly what the word implies; work. It’s not supposed to be fun—it’s work. We are not going to get rid of the welfare class in this country as too many people are dependent upon government largess. What we must realize, though, is that great wealth such as this country has, will always find a class of people, led by politicians, who want to get some of that money for nothing.
What does this have to do with the stock markets? It serves to make the point. Our giant U. S. corporations who operate in world markets are going to continue to expand their businesses into markets where their earnings are not going to be unreasonably confiscated by government. That’s a significant percentage of the world’s population as Europe, North America and Japan (roughly 750 million people or 12% of the world’s population) are thought to own, or control about 75% of the world’s assets. That leaves markets available to be penetrated representing upwards of 85% of the world’s population. Those are the future markets of the great U. S. corporations. Big companies will hold their own in high taxation markets, and foreign sales outside of those markets will explode.
Securities Representing Buying Opportunities
Now, let’s take a look at some stocks it makes sense to begin accumulating, even in these highly volatile markets. There is no such thing as a “can’t miss” stock, but here are some securities that are pretty close: Altria (just bought UST), Automatic Data Processing, Bank of America (if you have the courage), Coca-Cola, General Electric, Home Depot, Johnson & Johnson, McDonalds, Minnesota Mining and Manufacturing, Pepsico, Proctor & Gamble, Sysco, Wells Fargo, Genuine Parts, Nucor, and United Parcel Service. All of these stocks are undervalued by historical standards, all are A-rated stocks, all pay a dividend of at least 2.5% of the price of the stock, all of these companies lead their industry, and all of their securities are selling at price earnings ratios far below their historical average.
Market Considerations
This market is not without risk. Several months ago the price earnings ratio of the Standard and Poor’s 500 Index was 19 and now it has deteriorated to 24. Both the market and corporate earnings, are off about 20% from the market’s peak of October 9th, 2007. Jeff Kleintop of LPL Financial in Boston has developed a model based upon EPS estimates for 2009 that projects a current price earnings ratio of 2009 estimated earnings of only 12 times earnings. Equally highly regarded economist David Rosenberg, of Merrill Lynch, projects S & P 500 2009 earnings of $63, making a forward PE, based upon 2009 earnings of 20, rather than 12. This clearly represents a divergence of opinions on where the markets are headed.
What all of the above scenarios have to do with the price of bread is exactly what we started out with in the first paragraph: nobody knows what is going to happen to the market, short term. We are mired in stagflation like we were in the 1980s, and both the Fed and the U. S. Federal Government have pulled out all stops to help mitigate downward pressure on the economy: the Fed has caused the M3 money supply to explode on the upside, and the U. S. Federal Government is setting spending records, both actions being classic Keynesian Economics to get an economy out of a recession. Will it work? Who knows? But the bottom line is that America is literally “on-sale”. Foreign money is purchasing our goods like mad, causing our exports to explode and demand for the dollar to increase, which is why the dollar has gone up recently against other world currencies, especially the Euro.
Conclusion
While we may be in a hurry, the market never is. The market actually works pretty well even though, as NYU Professor Nouriel Rubini points out, “the problem is not the sub-prime mortgages, it is America’s sub-prime financial system. If anyone had predicted such an outcome 25 years ago, the authorities would have locked them up as insane”. Maybe Professor Rubini is right about our financial system; but, market forces are in the process of straightening the financial system out once again, the end result of which is going to be huge buying opportunities in the stock market. We have seen many stock market declines (those of us who are over 60!). Even though there is high volatility in the market—higher than ever before in history—it does appear that the market has discounted most of the bad news out there and that we are close to the bottoming out process for stocks. Now is the time to continue to accumulate high yielding, low price earnings ratio, A-rated, dominant stocks.
Carpe Diem.
George Rauch
September 12, 2008
