How low can you go?

A lot people are wondering how bad the stock market can get.

I don’t know how low it will go, but I have a pretty good idea of how low it can go.

Before I outline my reasoning, let me forewarn you: the answer is ugly.

I’m not trying to predict what the market will do or when–no one really can. I’m just trying to prepare you for the worst case scenario just in case it happens.

You don’t want to sell at the bottom. Nothing will hose up your long term goals as much as going to cash in hopes you can sell at the top and buy at the bottom. The odds are highly in favor of you doing just the opposite–most people do. Knowing how bad things can get may help you avoid selling at the bottom, and that’s what I’m trying to do in this blog.

The reality is I’ve never been as bullish as I am now. I’m projecting the highest returns going forward I’ve seen in 13 years! I’m terribly excited about the returns I believe I’ll get over the next 5 years. But, and there’s always a but, the stock market could go a lot lower before it goes back up again.

How low? History indicates the market can get as low as 7 times normalized earnings. I’ve talked about normalized earnings in the past, but let me explain it again briefly.

The stock market’s per share earnings have grown quite steadily at around 6% a year over the last 50+ years. In boom times earnings are above this trend, and in bust times earnings are below. But, over time, the earnings always return to trend.

Such earnings are like true north to a navigator. They point the way in all circumstances and provide a ready reference for where you are and where you’re going.

That’s why I use normalized earnings–it’s a steady guide. In boom times, the stock market sells at over 20 times earnings. In bust times, it tends to go down below 10 times earnings. In the worst times, it gets down to around 7 times normalized earnings.

What would 7 times normalized earnings mean for the S&P 500? Normalized earnings in the next year for the S&P 500 will be around $67 a share. 7 times that gives you a value of $469 for the S&P 500, roughly 52% below today’s closing price of around $970 on the S&P 500. That would correlate to a Dow Jones Industrial Average of $4,500.

I’m not saying we’ll get that low. In fact, I consider that quite unlikely. I’m not saying I want to see it go that low–I’d feel terrible if it did. But, I am saying be prepared for it to go that low just in case it does.

Benjamin Graham, the father of value investing, once said you shouldn’t invest in the stock market unless you’re ready to see your investment cut in half and double in value. I agree with that sentiment. Be prepared for the worst, hope for the best.

On a brighter note, the stock market usually trades at an average of 15 times normalized earnings. That would mean an S&P 500 of around $1,000 and a Dow of $9,600. In other words, the market is already below fair value.

The problem is the stock market almost always goes below fair value after boom times. It already has, but could go lower still. Be prepared for how low it can go and don’t sell at the bottom.

Like I said above, I’m finding the best values I’ve found in years. Great companies are selling at prices that are likely to generate very high returns over the long run. Even if things go significantly lower, this is an absolutely great time to invest!

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

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Hanging in there is tough, no doubt about it

October has been a brutal month.

I saw this crisis coming years ago, and my returns have benefited from that foresight, but this hasn’t kept me from feeling the pain.

I was feeling pretty good about myself at the end of September. Having beat the market by more 8% over the last two years and by more than 4% over the last three years (annualized, after fees), I was feeling pretty cocky.

But, that was before October. In October, my returns have paralleled the market’s path down. I haven’t enjoyed the ride, even if I started from a higher place.

This has been particularly frustrating because I’ve invested in some of the strongest companies around. You’d think the strongest businesses would be untouched, or much less touched, by recent turmoil.

That hasn’t been the case. When people are under a lot of pain, they do crazy things, like selling great companies at huge discounts to underlying value. Many of those investors were probably buying on margin. Some were hedge funds that were forced to sell long positions and cover short sales after the SEC banned shorting certain companies.

What’s been happening is the usual capitulation you tend to see when markets are bottoming. People are under so much pain that they’re selling everything, regardless of the price they’re getting.

This isn’t fun for a value investor like me because I hate to see my clients’ money or my own money decline in value. I work hard to be sheltered by the storm, even though I know some markets are so brutal that everything goes down.

What’s a person to do? I’m on a buying spree.

I’m taking the opportunity to sell strong performers and buy poorly performing great companies. I’m finding some absolutely astounding bargains and, most likely, boosting future returns. And, although it’s no fun to see the market and portfolios go down dramatically, I’m having a lot of fun putting things in place to benefit when the market does recover.

When will the market recover? No one knows. The market could go down by another 33% to hit historical lows reached in the past, or it could rally by 67% (a 40% decline requires a 67% increase to get back to break even) as it’s also done in the past.

You don’t need to be a fortune teller or have a crystal ball to make money from here, you just need the gut wrenching fortitude to buy great companies at great prices–now. As long as you believe our economy won’t permanently collapse, this is a great time to invest.

Although it’s no fun to live through, I’m quite confident that buying at times like this make for very high long term returns in the future.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

With trouble comes opportunity

Things look pretty grim out there right now.

Credit markets are freezing up. Unemployment is climbing. Housing sales, both existing and new, are hitting new lows. Orders for durable goods are down signficantly.

Our government has helped bail out 3 of the 5 largest investment banks. Fannie Mae and Freddie Mac, upon which the housing market depends so much, are in our government’s conservatorship. The largest insurance company in the world, AIG, has sold itself to our government’s majority ownership. Washington Mutual, the largest thrift bank in our nation, was siezed last night and parts were sold off to JPMorgan.

The U.S. executive and legislative branches are struggling to put together a multi-billion dollar plan (the bill will probably come to over a trillion, in my opinion) that will allow the government to purchase and liquidate currently illiquid securities. The Securities and Exchange Commission is preventing a growing number of companies from being sold short.

Baby, it’s cold outside.

So, where are the opportunities? Let me tell you!

The only thing building up faster than the credit market “snow” outside: bargains! I’ve never seen so many great quality companies selling at cheap prices. And, best of all, the strongest companies are able to grow while weak companies are wallowing in too much debt.

It’s always hard to buy when things look bleak, because they almost always seem to get bleaker. But, that shouldn’t prevent a long term investor from taking advantage of the great opportunities available right now.

It’s hard to remember how things looked in the fall of 2002 and spring of 2003. It’s hard to remember how bad the market and economy looked in the fall of 1990 and spring of 1991. It’s hard to remember the brutal recession of 1982 that followed a recession in late 1979 and early 1980. Same for 1974 and 1970, and on back in history.

The best time to invest is when things look terrible! That doesn’t mean we are at a bottom in the stock market–no one can predict that with any degree of accuracy. But buying when things look terrible has been a pretty good method to use over time, and now looks pretty dreadful.

With touble comes opportunity. This is an outstanding time to invest, and I will be glad to point back to this point in time several years from now and say, “wasn’t that a GREAT time to invest!”
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.