What’s beating the market down?

A lot of things are coming together to cause the market to go down, recently.

One issue is lower earnings forecasts for the 3rd and 4th quarter. Companies reporting 2nd quarter earnings are saying things don’t look that great for the rest of the year. This is knocking down stock prices. As investors optimistically begin to look forward to 2009 this fall, I expect the stock market to rally.

Another issue is uncertainty over upcoming elections. Markets hate uncertainty, and until it becomes clear who will win upcoming elections (both Presidential and Congressional) and what those elected will do, the market will do poorly. As that uncertainty clears up this fall, I expect the stock market to recover.

A third issue is the housing market. Housing inventories are very high, home sales volumes are low, and home prices continue to decline. Not only is housing an important part of our economy, it’s also a major part of most consumers’ wealth. Depressed consumers spend less, and that is reducing stock prices. When the housing market shows concrete signs of recovering, and I have no idea when that will happen (although I’m guessing late this year or early next), I expect the stock market to resume its climb.

A fourth issue, strongly related to the third, is the financial services sector. Banks are seeing their loans to consumers and businesses sour. At the same time, consumers and businesses need the money they put with banks as deposits to cover their needs as the economy slows. This perfect storm is hurting banks in a major way. After the housing market, and thus consumers and businesses, begin to recover, so will the banks.

A fifth issue is energy prices. Although energy prices have pulled back, no one is certain whether they will continue down or climb again. My guess is that high energy prices have both brought more supply online and reduced demand, so I expect energy prices to continue to decline in the short run. If such a decline becomes more clear, I think the market will rebound.

The way I see it, there are both short and long term issues at hand.

One short term issue is the market’s transition from looking at 3rd and 4th quarter earnings to looking forward to 2009 earnings. Another short term issue is election season. Those two issues are relatively easy to predict and should tend to lift market prices some time this fall.

Two long term issues are the housing market and financial services sectors. I don’t know when these two will recover, but when they do it will be a major and longer term lift to market prices.

Energy is both a short and long term issue. In the short run, I believe energy prices will come down and tend to support the economy and market prices, especially this fall. In the long run, I don’t believe it will be easy to find supply to keep up with growing demand, and higher energy prices will tend to undercut the economy and market prices. This dynamic is very difficult to predict.

I expect market prices to continue to decline into early fall, as investors focus on current economic conditions and election uncertainty. Such a decline will be tempered by declining energy prices and accelerated by rising energy prices.

In the longer run, the market will not begin a long term climb until the conditions in the housing market and financial sector improve. I can’t predict when this will happen, but it may happen this fall or some time next year.

In the much longer term, as the economy recovers and demand picks up, so will energy prices. This will dampen the market’s rally to some degree.

Although I don’t use market predictions to time the market, I believe an understanding of market dynamics are useful for investors who are trying to understand what is happening and when it will improve.

The best time to buy is when things look terrible, and the best time to sell is when things look great. Whether the market rallies this fall, next year, or 3 years from now, I believe this is 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.

Advertisements

Comparing apples and oranges

What would you say if I told you the market was over-valued by 30%? Would you think I was full of it?

What if I told you that this over-valuation were based solely on market commentators comparing apples and oranges?

When someone says the market is fairly valued or over-valued, what do they mean by that? What standard are they comparing it to? This may seem like a pie-in-the-sky question, but it’s very important.

Why? Because market commentators are frequently saying the market is fairly valued by comparing apples and oranges! And, the two are off by 30%.

You see, many say the S&P 500 is fairly valued because they are comparing the S&P 500’s forecast, operating earnings to the S&P 500’s actual, reporting earnings. But that’s comparing apples and oranges.

This may seem like technical minutia, but it makes a big difference. In fact, operating earnings of the S&P 500 have been 20% higher than reported earnings over the last 5 years. And, forecast earnings for the S&P 500 have been 10% higher than actual earnings.

In other words, when commentators say that the S&P 500 is trading at its historical average, they are comparing apples (forecast, operating earnings) to oranges (actual, reported earnings). And, those apples are 30% overstated compared to the oranges.

Next time you hear someone say the market is fairly valued, ask them if they are comparing apples to oranges. Are they comparing forecast, operating earnings to the historical average of actual, reported earnings? If so, tell them to adjust their numbers and get back to you when their figures are fairly comparing apples to apples.

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.

My latest client letter is available

For those of you interested, my latest client letter just came out today.

In it, I discuss client account performance, my projections for the market over the next 6 years and my opinion on the economy, Part III of my assembling portfolios segment dealing with investment probabilities, an investment spotlight on Microsoft, a segment on why the subprime mortgage market impacted equity markets, and my section on admirable business people covering Benjamin Graham–the father of value investing.

If you get a chance to read it, please tell me what you think and what could be improved.

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.