Is the S&P 500 finally bottoming?
In October of last year, Warren Buffett wrote an op-ed in the New York Times announcing his intention to buy U.S. equities. In the months since, we’ve seen the markets oscillate wildly but ultimately head only further down into its trough, sparing no one in its path. Was he wrong? Is it still not safe to get your money back into the stock market?
For those that follow Warren Buffett, his recommendation is not just a far out attempt to be contrarian as his op-ed piece makes it sound. Yes, the general tenet to be “fearful when others are greedy and greedy when others are fearful” will serve most investors well. But, Mr. Buffett has backed up this tenet with a very interesting bit of theory based on the total market cap of U.S. stocks versus its gross national product as outlined in a 2001 talk given by Buffett, himself.
Today, we see that the market has only continued correct as he predicted in 2001.
Chart courtesy of GuruFocus.com
It seems that the market has finally returned to long run equilibrium values. This, too, is mirrored by overall P/E valuations in the S&P 500.
Chart courtesy of FinancialSense.com
In fact, according to the S&P, the index reached a valuation of just 13.7x 2008 earnings by December 31 and currently trades at 11x projected 2009 earnings. Unfortunately, some people out there believe that there’s even more for us to fall. Last Friday, Barry Ritholz claimed that his analysis lead him to believe that the S&P’s fair value would be just 440 given equilibrium P/E and trailing reported EPS. As far fetched as this sounds, we can’t forget that in the last few major recessions, market lows gave rise to valuations with high single digit P/Es (1919-1923, 1931-1932, 1942, 1977-1982, etc.)
All these conflicting analyses is likely confusing especially for investors who have been burned by the recent market slide and may be wary of committing new capital. It can be tempting to try to sit and wait for the bottom. It is very difficult, however, to be successful in such a tact. A recent study by the Charles Schwab Chief Investment Strategist, Liz Ann Sonders, found that over the last 10 years the 40 best market return days accounted for would have meant the difference between an annualized 8.4% return and an annualized 6.4% loss. Not only that, but 75% of these top 40 days came within two weeks of a market worst day.
Given the difficulties of timing the market, there must be a way to capitalize on depressed market values. We’ve established that the markets are currently trading just below long-term equilibrium values implying significant upside. And, knowing that the last year has been equally severe to nearly every equity class, a strategy of broadly entering U.S. equities through a modest and tempered commitment (taking advantage of the phenomenon of dollar cost averaging) of new capital will likely yield better than average results for anyone with a long term horizon.
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Interesting analysis. Unfortunately, given the historical results of the last ten-fifteen years for equities versus fixed income, there still seems to be few compelling reasons to get involved in the equity markets. It was not so long ago that stock brokers (as compared to “investment advisors” and “financial planners”) cautioned investors that the only money that they should invest in the stock market is money that they are prepared to lose. Seems in retrospect that this was pretty good advice. The “buy and hold” investment philosophy was invented by the investment industry was totally self serving with the objective of generating fees and not investment returns. Warren Buffett has the luxury of looking at a time frame that few of us share. We are not transferring wealth inter generationaly but rather looking to use up our capital through the course of retirement. Most seem to have forgotten the expression coined by that great economist John Maynard Keynes. In the long run, we are all dead.