Let's face it, the last time Bill Gross, manager of the $800 billion Pimco Total Return Fund, was bullish on stocks was a long-time ago. Indeed, in 2002, he said stocks were on their way to 5,000. Shortly thereafter a bull market began that drove stocks, ultimately, to 14,000. But then again, why would a bond manager ever put in a good word for stocks. That's not his "job." His job is to tout bonds. Today Mr. Gross said that bonds were a better buy than stocks. I agree that corporate bonds and some preferred stocks, which have bond-like qualities, are very good values, and we have been nibbling on them and will continue to do so. Having said this, stocks, in my mind, are dirt cheap compared to riskless US Treasury bonds. For the first time since 1958, the dividend yield on the Dow Jones Industrials at 3.65% is higher than the 2.7% yield on a 10-year T-bond. In addition, the Dow Jones Industrials are now trading at a P/E of about 11 times operating earnings. If you invert P/E, you get what is called earnings yield. A P/E of 11 equates to about a 9.9% earnings yield. The importance of earnings yield being this high is that if you owned the averaged company in the Dow, you would be earning about 9.9% yield on your investment from the income alone, irrespective of any future capital appreciation. In the lexicon of Warren Buffett and big investors of his ilk, earnings yield is seen as owner's income -- the money they can make from buying the whole company. In short, stocks as cheap as they are today will at some point kick off a buying spree from big money players. The only reason it has not happened yet is because stock prices have not been able to find a bottom. When the bottom is formed and tested, I predict a wave of takeovers will begin that will carry stocks to higher levels than most people would now believe. These are my personal thoughts. Please do not act upon anything I have said here. I'm just passing on my thoughts for what they are worth. Please consult your own investment advisor.
Tuesday, December 02, 2008
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5 comments:
While the dividend yield is high on the Dow Jones Ind. and the P/E is "only" 11, it is that on trailing earnings. While the "P" may seem low, the "E" is high, and likely quite distorted. We are just coming off a 4 decade high water mark for corporate profits margins which is not sustainable in a normal market and certainly not in the current one.
Also consider that in many of the more serious markets, the P/E of the market bottomed in the high single digits, like 8... As an example, a 33 dollar stock with a PE of 11 would have to drop 27% further to obtain a PE of 8...
Now, imagine that the E drops making the P/E go UP. The P would have to fall to make it "cheap" again.
The dividends of several Dow stocks are questionable. That will affect the yield and make it lower should dividends be lowered or removed.
I agree with Indy in that people are in for a rude awakening with regards to analyst estimates for
'09. Analyst estimates seem to have gotten worse and worse over the last several years yet they are still used as guidance.
Assuming peak earnings of $92 on the S&P 500 in 2007, and using an aggressive 35-40% drop in earnings given the magnitude of this recession, we are looking at '09 earnings on the index in the 55-60 range.
Again, agreeing with Indy that multiples are likely to retract given the current environment, and a 10-12 multiple on the above earnings puts the S&P 500 in the 550-720 range.
Now it could be argued that a majority of the selling is done, and having sniffed out the 750 range on the S&P is reassuring that maybe in fact a bottom is forming. But with a limited growth driver at this point, its hard to argue for higher earnings or higher multiples at this point. Thus, stocks, at least in the aggregate, may not be as "cheap" as many argue. And any significant rallies, will continue to be shortlived, at least in my opinion.
Fear is high, because risks are high. Now, I personally would much rather purchase the S&P 500 in the 800's than the 1,500's, and am doing so, but I also know that there may be better absolute return opportunities, particularly in a deflationary environment, than stocks. Especially when the government is changing the rules on a daily basis.
Hope you had a good thanksgiving; Merry Christmas.
Dave G.
I completely agree with the comments made by the others. We all need to remember that the seemingly reasonable PE of the last several years was based on historically high profit margins. As these margins revert to the mean, and I have not heard a single argument that they won't, we will see PE's that are founded on more "normal" profit margins. Furthermore, as everyone has pointed out, PE's tend to contract during times of uncertainty and recession.
Thus, while I do feel this is a reasonable time to make selective stock purchases, I'm also very aware that the market has a very likely chance of falling below the recent bottom of 750 on the S&P. The S&P in the 550-750 range would not be unprecendented considering the current levels of financial and economic distress.
You know I hate being the counter-weight on these posts, but I do it because I feel it is additive to the thought process of those reading, and for me to place my thought somewhere.
Greg is undoubtedly correct about what will happen when the bottom is found. I simply do not think it has been found yet.
And just because Bill Gross (bless his small fixed income heart) was a great contrary indicator in the '01-'02 debacle does not mean he will always be. If anything, since this mess is very much driven from the credit side of the street, people should pay heed to the few over there willing to speak to us lessor equity fellas...
Correction: a P/E of 11 equates to about a 9.1% yield, not 9.9%.
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