eRollover.com
By Mike Rowan
Is this a Historic Buying Opportunity for Stocks?
Everybody knows that the stock market has plunged.If you have received your quarterly statement for your 401k, 403b, IRA, or other investments, you are more than likely aghast when seeing the losses on paper. I have heard many different arguments with regards to whether this is a historic buying opportunity, or a preview of an even more severe economic downturn.
Some of the country’s most famous investors, including
Warren Buffett and John Bogle, have started to make the case that it’s time to dive back into the stock market.
They are usually careful to add that they don’t know what stocks will do in the short term. Yet their basic message is clear enough: stocks are now cheap, irrational fears have been driving the market down lately, and people who buy today will be glad that they did.
Another camp is bearish due to the fact that Barack Obama has been elected, and they fear that the capital gains tax and personal income tax may dramatically increase in the near future. This can be attributed to the sell off that we are currently seeing in the markets.
But there is another argument that deserves more attention than it has gotten so far. It’s the bearish argument that is based neither on fears that the country may be sliding into another depression nor on gut-level worries about the unknown. It is based on numbers and history, and it has at least as much claim on reason as the bullish argument does.
It goes something like this: Stocks are truly cheap only relative to their values over the last 20 years, a period that will go down as one of the great bubbles in history. If you take a longer view, you see that the ratio of stock prices to corporate earnings is only slightly below its long-term average. And in past economic crises — during the 1930s and 1970s — stocks fell well below their long-run average before they turned around.
To make matters worse, corporate earnings have now started to plunge, too. Assuming that they keep dropping, stocks would also need to fall to keep the price-earnings ratio at its current level.
There are any number of ways to measure the valuation of the stock market. Some examine prices relative to earnings, others are based on cash flow, a company’s underlying assets or the total value of the market. But they tell a pretty consistent story right now. Stocks, which were fabulously expensive for much of the 1990s and this decade, no longer are.
The 10-year price-to-earnings ratio tells an incredibly consistent story over the last century. It has averaged about 16 over that time. There have been long periods when it stayed above 16 and even shot above 20, like the 1920s, 1960s and recent years. As recently as last October, when other measures suggested the market was reasonably valued, the Graham-Dodd version of the ratio was a disturbing 27. But periods in which the ratio has jumped above 20 have always been followed by steep declines and at least a decade of poor returns.
By 1932, the ratio had fallen to 6. In 1982, it was only 7. Then, of course, the market began to self-correct in the other direction, and stocks took off.
Where will we be 1, 2, or 5 years from now? I wish that I had a crystal ball, but I would say that you have to keep on buying and dollar-cost averaging in your 401k, IRA, 403b, or other retirement accounts. You may look back and be glad that you did. Hopefully, that is.
