Charts SYSTEMS

[JLS]

gdl, re valuations ...

It seems like you can deal with differences of opinion without running away and crying. So allow me to poke you with a stick, and we'll see how it turns out.

You wrote, "We are very over stretched for a bear market based on valuations."

I think the best way to determine valuations is to compare the yields of alternatives. So, what are the alternatives for most people? CDs and um ... um ... um ... oh, now it comes to me ... bonds. Oops, forgot, some people like cash and shiny objects like gold.

Well, we know stocks have been yielding something pretty good, even the ones that don't pay dividends, but I hesitate to put a number on it. So, come up with a number yourself and I'll accept it if you have a genuine guess.

So, what do you think the yield is now for CDs, and how long do you have to hold them to get it? Maybe we should just forget that idea because to get 2-3% you gotta sometimes plunk down a bunch and hold them for 3-5 years. There aren't going to be too many takers on that.

Bonds? The ones that pay pretty good are risky, and that's why they pay pretty good. So the risk averse will not buy them over buying stocks. And if interest rates go up, the price of all existing bonds will go way below face value. Some investors might buy the older bonds at a discount, but I doubt it because they will feel that they have to hold them to maturity to derive their profits while they watch the stock market chug higher and higher.

Cash? Nope -- negative yield after inflation. Gold? Nope, it's going down as the banks get stronger. The fear factor is fading away.

I'm not good at this, so I can't think of anything else.

Oh, let's look at average valuations of stocks. This means we must consider the fact that some stocks are overvalued while other stocks are undervalued. We have to recognize that good stock pickers can make money by trading stocks that are undervalued while lousy investors loose their money while trading stocks that are overvalued. In other words, the market can stay relatively flat while there is sector rotation. Another way of saying that is that some sectors can easily have their personal Bear market for good portions of next year while other sectors have a Bull market for much of next year. You know, like in the '90s -- some pretty good rotational corrections but no Bear in sight. In fact, history has shown that a lot of very good S&P years are directly followed by another one. And in this case, that would be next year.

So much for average valuation. The real question is whether the market is overvalued when compared to alternatives. I say it is not even close to being overvalued. It is actually realistic to ignore historical PEs as a guide to valuation. Why? Because they were at times when interest rates were much higher. Interest rates are still very near record lows. I don't see any reason why product prices are going to go down while the economy slowly gets better, and home prices continue to rise. Doesn't really make sense that people wont be feeling a little richer and start spending a little more. I do see that energy prices can go down, at least in this country, as we have a glut of natural gas and we have a near record storage of oil as we find more than we know what to do with. In fact, by 2015 the US is going to start being a major exporter of natural gas; and probably a much bigger exporter of oil. And you know where exports go. They add directly to GDP.

So, instead, let's look at the value of the S&P500 versus corporate Sales and Book Value. In the charts below, one division is two years. I don't see much of a change from last year, particularly when looking at Price to Book Value -- and it's Book Value that you own when you buy stock. The market certainly isn't "over stretched". Look at 2003 to 2007, then compare that to now while considering that interest rates were much higher then.

If you do a little math and normalize either of those charts to interest rates, the market is way undervalued now. The stock market can continue to go up while interest rates go up, and the ratio will stay the same. If you want a serious correction, then there has to be a threat of recession, and that isn't in the cards until there is a threat of interest rate inversion. And while the Fed is holding down short-term rates, that isn't going to happen.

So, you and me, let's stay Long and climb the Wall of Worry and make lots of moola.