Insights & Advice

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Are We There Yet?

“This has to be the bottom, right?”

“Why?” I ask.

“Well the market went up 10% in one day, that’s a record, right?”

“So?”

“I mean the elections are Tuesday. October’s over. Shouldn’t the market rally?”

And so it goes. Client after client called me this week, flush with cash, sitting on the sidelines, just panting to get in at the “bottom”. Three weeks ago the same people were bailing out, absolutely certain that the markets would never come back in their lifetime. A psychologist would label it schizophrenic behavior. I just call it emotional and over the last couple of decades I’ve learned that emotions have no business in the investment process.

Now one can hardly blame the investor, especially those closest to retirement, for wanting to get back some of the money they lost as fast as they can. Yet, in my opinion, that is a sure way of losing even more money. No question the markets offer great values but value does not necessarily equate to instant rewards. I suspect some investors are confusing the two.

Value in the context of fundamental analysis is usually dictated by the price/earnings multiple of the S&P 500 (among other indicators). In other words, how cheap are stocks based on their earnings? Right now the P/E of the market is about 9.7 times earnings compared to a ten year market average P/E of 17.8. So given their earnings, stocks are selling for almost 50% less than they have for anytime in the last ten years. No wonder Warren Buffet says stocks are cheap.

Yet cheap does not mean that investors will rush in to buy stocks or that prices will react immediately. That occurs in bull markets and only when most stocks are relatively expensive. In bear markets, when the economy is in recession as it is now (see Thursday’s column “The Economy reverses”), stocks can remain cheap for an awful long time. So don’t expect value to equal a quick buck.

As we close out the month the major averages were down substantially (the worst decline in 21 years) with the S&P 500 declining 17%. It was the worst monthly sell-off in 21 years (in October, 1987 the index declined 21.8%). Yet, as I predicted the markets were so oversold that a move up was expected. In this last week the major averages all managed to stage strong rallies chalking up an average 10% gain overall. It was also the first time all month that the markets managed to stay positive for two consecutive days.

Next Tuesday the presidential elections may spark a further rally, possibly sending the S&P 500 up to around 1050. That would be a gain of about 25% from its intra-day low of October 10. But I think that would be about it for this bear market rally. After that, I suspect we will re-test the lows and hopefully they will hold. So go out and have a Happy Halloween—you deserve it!

Posted in A Few Dollars More, At the Market