Click here to listen…
Been Down so Long it Looks Like Up to Me
–Richard Farina
The Current Dilemma.
Now that the stock market has rallied, investors are in a quandary. Should they continue to hold stocks and hope to recoup more of their money back, or should they sell into the rally in the hope of avoiding more carnage if the market falls once again? They ask themselves: “What if this is just a rally in a continued bear market? They would be right to think so, just look at the chart below.
Chart 1
Every single market rally was followed by a decline, some benign and some quite vicious (August 2008 -December 2008). The same thing happened between 2000 and 2003.
Chart 2
However, instead of continuing its downward slide like most experts forecasted, the market entered a new bull phase lasting until November 2007. Chart 3 shows the rise starting in 2003.
Chart 3
Putting It Into Real Dollars
If the value of your 401k or IRA stood at $500,000 on October, 2007, it would have declined to $225,000 by February 2009. One month later, the value of your investments would have been grown back to $275,000 (Using the S&P 500 as our proxy).
Therefore any rally as represented in Chart 1, would have represented a selling opportunity. For example, by March 10th 2008 your $500,000 would have declined to $415,000. By November 17th, it was valued at $254,000.
Just like the 2003 period, we never know if the previous bottom is the final bottom. Unfortunately, looking at the past does not give us enough information to predict the future. Like driving, looking only in your rear view mirror, the past may give clues, but its ability to forecast is limited.
Is There Any Way To Cope With This Uncertainty?
Yes, but the first thing to do is take a fresh look at today’s environment. Put the past behind you and look forward. Ask yourself if the economic landscape has changed since those dark days of 2008?
I would have to say that compared to the terrible events in October and November 2008, we have seen positive changes in financial markets. It is just a flicker of change, but change nevertheless. I know, a flicker is not a flame and a few drops of water do not make your glass half full, but notable changes are taking place. Here is a short list:
1) The Government has stepped in and backed nearly everything.
2) Banks now have new rules regarding the pricing of their bad assets.
3) Banks are starting to lend again. As a matter of fact, Bank America just announced they are re-entering the jumbo mortgage market.
4) GMAC, the financing arm of General Motors, also said Wednesday that it would resume making loans to subprime borrowers in order to spur sales.
5) The decline in orders for a number of companies is beginning to flatten out; suggesting the rate of decline is slowing in many cases.
6) Production in increasing in China.
7) The stimulus has not even started yet.
8) Interest rates are at historic lows.
9) The price of oil is showing signs of life.
The jury is still out and many economic challenges remain and many smart people continue to predict the economy will get worse before it gets better. However, there is a sense on my part, of an end to the free-falling economy and stock market.
How Does One Make A Decision Under These Stressful Conditions?
One way is to try and determine if the stock market is “under-valued”, “over-valued” or “fairly-valued”. A person I respect, who has studied valuation successfully for many years is Jeremy Grantham, head of GMO. (Click on the link to find out more about him). Grantham uses a simple investment idea in a sophisticated way to determine “fair-value”. He also understands there will be times when the markets will go too high and too low relative to “fair-value” and he knows that what goes up will eventually come down and vice versa. He calls it “regression to the mean”.
The chart below shows the performance of the “DOW” from 1965 to 2007. The straight line going up the middle is the trendline or average. The tech bubble is the area above the trendline between 1998-2001. Interestingly, after the big decline in 2002, markets did not go below the trend line, indicating a move back to fair-value. The market rose again until 2007, declining dramatically bringing the market to what appears to be a significantly “under-valued”. This is a simplistic picture and not meant to directly reflect Grantham’s calculations, but it does illustrate the point.
Grantham thinks fair-value is currently around 900 on the S&P 500 (The DOW is not a very good measure of the market anymore). Today the S&P 500 stands in the lower 800′s, having sunk to a low of 675 on March 9th, 2009.
This is information we can use. We can be more assured of success buying below the trendline than either at it or above it. The only problem, as Grantham has experienced on more than one occasion, is the curse of being TOO early. These trends of over and under valuation do not change overnight. Sometimes they can last for years and be quite frustrating. If the market is over-valued and you sell, it can continue higher and make you feel you are losing opportunity. If the market is under-valued and you buy, it can become even more under-valued making you feel you have made a big mistake. During the period between 1995-2000, Grantham shouted loudly that the market was severely over-valued and was deemed dead wrong for 3 years. He stuck to his guns however, and even in the face of losing many accounts, he was eventually validated. (Warren Buffett often suffers the same fate).
Today, while everyone is screaming the “sky is falling”, Grantham is buying stocks during the deepest of the market declines. He can do this because he is willing to be wrong for periods of time thinking he will eventually be proven right.
My job is a bit different. I must take a more exacting course because my first concern is to preserve capital. Instead of grabbing the extreme bottom or top of the market, my philosophy is to grab the middle two-thirds thinking that it should be enough to create wealth over the long term.
To this effect I remain cautious but poised at the trigger to enter at the “right” time.
Click here to listen…
Been Down so Long it Looks Like Up to Me
–Richard Farina
The Current Dilemma.
Now that the stock market has rallied, investors are in a quandary. Should they continue to hold stocks and hope to recoup more of their money back, or should they sell into the rally in the hope of avoiding more carnage if the market falls once again? They ask themselves: “What if this is just a rally in a continued bear market? They would be right to think so, just look at the chart below.
Chart 1
Every single market rally was followed by a decline, some benign and some quite vicious (August 2008 -December 2008). The same thing happened between 2000 and 2003.
Chart 2
However, instead of continuing its downward slide like most experts forecasted, the market entered a new bull phase lasting until November 2007. Chart 3 shows the rise starting in 2003.
Chart 3
Putting It Into Real Dollars
If the value of your 401k or IRA stood at $500,000 on October, 2007, it would have declined to $225,000 by February 2009. One month later, the value of your investments would have been grown back to $275,000 (Using the S&P 500 as our proxy).
Therefore any rally as represented in Chart 1, would have represented a selling opportunity. For example, by March 10th 2008 your $500,000 would have declined to $415,000. By November 17th, it was valued at $254,000.
Just like the 2003 period, we never know if the previous bottom is the final bottom. Unfortunately, looking at the past does not give us enough information to predict the future. Like driving, looking only in your rear view mirror, the past may give clues, but its ability to forecast is limited.
Is There Any Way To Cope With This Uncertainty?
Yes, but the first thing to do is take a fresh look at today’s environment. Put the past behind you and look forward. Ask yourself if the economic landscape has changed since those dark days of 2008?
I would have to say that compared to the terrible events in October and November 2008, we have seen positive changes in financial markets. It is just a flicker of change, but change nevertheless. I know, a flicker is not a flame and a few drops of water do not make your glass half full, but notable changes are taking place. Here is a short list:
1) The Government has stepped in and backed nearly everything.
2) Banks now have new rules regarding the pricing of their bad assets.
3) Banks are starting to lend again. As a matter of fact, Bank America just announced they are re-entering the jumbo mortgage market.
4) GMAC, the financing arm of General Motors, also said Wednesday that it would resume making loans to subprime borrowers in order to spur sales.
5) The decline in orders for a number of companies is beginning to flatten out; suggesting the rate of decline is slowing in many cases.
6) Production in increasing in China.
7) The stimulus has not even started yet.
8) Interest rates are at historic lows.
9) The price of oil is showing signs of life.
The jury is still out and many economic challenges remain and many smart people continue to predict the economy will get worse before it gets better. However, there is a sense on my part, of an end to the free-falling economy and stock market.
How Does One Make A Decision Under These Stressful Conditions?
One way is to try and determine if the stock market is “under-valued”, “over-valued” or “fairly-valued”. A person I respect, who has studied valuation successfully for many years is Jeremy Grantham, head of GMO. (Click on the link to find out more about him). Grantham uses a simple investment idea in a sophisticated way to determine “fair-value”. He also understands there will be times when the markets will go too high and too low relative to “fair-value” and he knows that what goes up will eventually come down and vice versa. He calls it “regression to the mean”.
The chart below shows the performance of the “DOW” from 1965 to 2007. The straight line going up the middle is the trendline or average. The tech bubble is the area above the trendline between 1998-2001. Interestingly, after the big decline in 2002, markets did not go below the trend line, indicating a move back to fair-value. The market rose again until 2007, declining dramatically bringing the market to what appears to be a significantly “under-valued”. This is a simplistic picture and not meant to directly reflect Grantham’s calculations, but it does illustrate the point.
Grantham thinks fair-value is currently around 900 on the S&P 500 (The DOW is not a very good measure of the market anymore). Today the S&P 500 stands in the lower 800′s, having sunk to a low of 675 on March 9th, 2009.
This is information we can use. We can be more assured of success buying below the trendline than either at it or above it. The only problem, as Grantham has experienced on more than one occasion, is the curse of being TOO early. These trends of over and under valuation do not change overnight. Sometimes they can last for years and be quite frustrating. If the market is over-valued and you sell, it can continue higher and make you feel you are losing opportunity. If the market is under-valued and you buy, it can become even more under-valued making you feel you have made a big mistake. During the period between 1995-2000, Grantham shouted loudly that the market was severely over-valued and was deemed dead wrong for 3 years. He stuck to his guns however, and even in the face of losing many accounts, he was eventually validated. (Warren Buffett often suffers the same fate).
Today, while everyone is screaming the “sky is falling”, Grantham is buying stocks during the deepest of the market declines. He can do this because he is willing to be wrong for periods of time thinking he will eventually be proven right.
My job is a bit different. I must take a more exacting course because my first concern is to preserve capital. Instead of grabbing the extreme bottom or top of the market, my philosophy is to grab the middle two-thirds thinking that it should be enough to create wealth over the long term.
To this effect I remain cautious but poised at the trigger to enter at the “right” time.
Posted in On The Money! Commentary | Tags: investing, money, stocks and bonds, finance, money market, money management, economy, mmarket, bear market, market, advisors, financial, investments