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Re: DewDiligence post# 4729

Friday, 11/21/2008 10:21:54 AM

Friday, November 21, 2008 10:21:54 AM

Post# of 4764
RE: The bargains are getting hard to resist.

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I hope you don't find this off-topic, because it no longer pertains to IMCL, but the story here is done anyway.

Dew, you are a very rational investor, and I mean that in the best sense, with the valuations you calculate, and you tend to act accordingly. My observation is that a strictly rational approach tends to bail out too soon on the upside, and enter too soon on the downside, because a rational valuation is the principal consideration. Before anyone gets the idea that I am advocating a Beach-style emotional approach, please drop that line for a second, and let me elaborate:

I have concluded over time (and a lot of reading on Austrian school economics, the only one that makes any sense to me today) that the biggest single factor, almost the only factor in stock values overall, ie. whether the tide is coming in or going out, is the amount of money looking for a return. In turn, that is dependent principally on the money supply, with allowance made for anomalies due to the demand for money. Demographics determine how much of the money supply goes into investments. Right now, money supply is going ballistic, but the demand for money is stratospheric also. That is why, for example, the Fed is unable to cure deflation by running the printing press: The dollars they create are filed away and used to shore up balance sheets, both at banks and at households. In regular times, the situation is a little different, where the demand for money is predictable, and supply is really the only factor influencing matters.

So how does this affect stock prices in general? It helps to think through the following: It is mathematically impossible for everybody to put $1 into the markets, and everybody to withdraw $2 (excepting dividends, which properly should be considered to increase the investment). Yet over time, the markets go up. Interestingly, Niall Ferguson of Harvard Business School showed a slide in one of his talks where he plotted the S&P500 since inception, against Gold, not dollars, and other than 3 peaks in the late 20s, the 60s, and the 90s stretching to present times but heading back down, the relationship was flat. There can be medium-term divergence, but long-term it looks like stocks and gold are both priced roughly the same. That tells me that the variable is fiat money, which declines in value as more is printed, making it look like the broad market is making gains. The recent peak in stocks was longer-lasting than the others, and I suggest that is due to the baby boom generation's feverish investing for their retirement. The gains were directly proportional to money flows into the markets, yet the understanding did not get out that this was the only reason for the gains, and that the gains would reverse when money flows reversed as those investors got their money out. Even without the present depression, the gains would eventually reverse as the boomers begin withdrawing money, and getting out of stocks to lock in gains. It is still a zero-sum game, with the first ones in and first out winning, the last in and last out, losing. Here, I have made no mention of PE ratios, because they are irrelevant for the market as a whole. When there is more money than investment vehicles, prices go up. When there is less free money (taking into account demand for money here), then prices go down. I saw Warren Buffet's behavior in recent years confirming this: He ran out of values in stocks, and looked everywhere else for returns, and everyone else followed, hence the housing bubble (aside: He thinks it is time to buy stocks now). My conclusion is that one should not invest in the broad market looking for capital gains, only dividends. I don't see that as attractive for a few years more, as earnings are going to take a beating and dividends will likely suffer also.

That leaves individual stocks, where capital gains are possible when the underlying business grows relative to the market, attracting new investors. But again, I don't intend to get in there until the tide has finished going out, even if values are getting really attractive. There is a reason why they say "when they raid the cathouse, they take the piano player also".

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