Of note in the articles below, while John Hussman and Bennet Sedacca are different stylistically, they both advocate in recent articles using metrics besides traditional earnings ratios to value the market (Hussman gives price to book and price to revenue as examples, Sedacca price/tangible book, price/tobin’s q, price/free cash flow). Also, John Mauldin gives us a sample of the HCM Market Letter by Michael Lewitt. A long read, but worth it. Excerpts at the bottom.
From Investment Postcards from Capetown, a good summary of where we currently stand in the market:
family:arial;font-size:85%;" >In short, the stock market still needs to do a considerable amount of work before evidence of a primary bear market low will be demonstrated. As a first step, the indices must clear their respective 50-day moving averages and the November 20 lows. (As mentioned before, the large deviations of the moving averages pointed to a massively oversold situation – almost like a spring that is stretched too far – and a measure of mean reversion was to be expected.)
family:arial;font-size:85%;" >It is possible that a rally may ensue and last until the release of potentially ugly earnings and guidance announcements in April. However, always remember the old adage: “bulls make money, bears make money, but trading against the primary trend makes for sleepless nights.”
From Investment Postcards, a rather depressing assessment of where the markets are headed by Bennet Sedacca (bold added):
family:arial;font-size:85%;" >family:arial;font-size:85%;" >This post is a guest contribution by Bennet Sedacca*, President of Atlantic Advisors Asset Management.
family:arial;font-size:85%;" >One of the misunderstood facts about bear markets is that they must be resolved in two distinct ways – TIME AND PRICE. History is full of examples of where markets should bottom based on a plethora of metrics. But when earnings estimates are nearly impossible to guess as the global economy spins out of control, we must revert to other measures that are far more tangible; price/tangible book value (note that I use tangible book value, which excludes those nearly worthless assets like goodwill), price/Tobin’s Q Ratio (Tobin’s Q is the replacement value of a particular company), and price/free cash flow.
family:arial;font-size:85%;" >While predicting future PRICES is a dangerous affair, it is even more difficult to grasp the other element of resolution – TIME, and how long it may take to reach the final destination at the bottom of the market.
family:arial;font-size:85%;" >My price targets over the past few years were for an initial stop of the S&P 500 at 750, then 600-650, then 500, then the eventual 450 level. Despite my expectations of miserable earnings and of global de-leveraging, I am sad to say that my ultimate targets may have actually been a bit too optimistic. My price target now for the S&P 500 is in the 350-400 range which is still a decline of 40-50% from current levels. My target in terms of time for the ultimate low for the S&P has been early to mid October 2010, which coincided with the typical October low in the second year of a Presidential Term.
family:arial;font-size:85%;" >As long-time readers may recall, I find the Presidential Cycle to be the strongest and most predictable cycle within the past century. A report out of Pepperdine University several years ago suggested that since 1952, if you had been invested in the S&P 500 from Day 1 of a Presidential Cycle until mid-October of year 2 of the term, a $1,000 investment would have turned into roughly $650, without even adjusting for inflation. If on the other hand you had invested from mid-October of year 2 of the Term and sold on the last day of the Presidential Term, your $1,000 would now be worth $71,000. Without a doubt, this is due to the relationship between stock prices, economic circumstances and Presidential Gallup Approval ratings which are amazingly synched.
family:arial;font-size:85%;" >Even if we are lucky enough to “guesstimate” the ultimate bear market bottom, this is only part of the equation. Making it through the bear market with the bulk of one’s capital intact is obviously Job #1. Buying at depressed levels, even within the confines of a secular or super bear market can be highly profitable.
family:arial;font-size:85%;" >Assuming we get the guesstimate even close to correct, we must then again guess just how long it will take before we start the next secular bull market. My guess is that it will take (holding my breath here) a period of 10-15 years from the secular bear market low, which I guess will be in 2010.
family:arial;font-size:85%;" >This decline has not been your garden variety bear market. Instead it has been a nasty, sometimes frightening, relentless move lower in equities, one that will be remembered for generations to come. Investing habits for many people will change for the remainder of their lives. Many will be forced to work well beyond their planned retirement age, sometimes at jobs they would not generally desire. The rebuilding of the banking, insurance, auto and other industries may take well over a decade as well.
family:arial;font-size:85%;" >There may be many cyclical markets lasting anywhere between 6 to 24 months along the way, market moves I fully intend to participate in. But my expectation as it regards the time to repair the economic problem is “Welcome to the Long and Winding Road”, or for me “When I’m Sixty Four” (I am currently 49).
For a more tempered analysis, I would recommend John Hussman’s Weekly Commentary. An excerpt from 3/9 (emphasis added):
As for the stock market as a whole, I continue to view the market as undervalued, but not deeply undervalued. So over the course of a 7-10 year holding period, I do expect passive buy-and-hold investors in the S&P 500 to achieve total returns somewhat above 10% annually. Shorter-term, however, investors may demand much higher prospective long-term returns in order to accept risk, and that’s a problem, because the only way to price stocks to deliver higher long-term returns is to drive prices lower.
While the stock market is extremely compressed, which invites the typical “fast, furious, prone-to-failure” rallies to clear this condition, my larger concern is that market action and credit spreads are demonstrating very little investor confidence, risk-tolerance or commitment to stocks. Value investors know that stocks have been much cheaper at the end of lesser crises, and traders are still sellers on advances. My impression is that only prices that allow no room for error (what Ben Graham used to call a “margin of safety”) will be sufficient to prompt robust, committed buying from value investors. This will be a fine thing for investors who keep their heads, are already defensive, and have the capacity to add to their investment exposure on price weakness, but other investors are likely to be shaken out of long-term investments at awful prices. This need not happen in one fell swoop, and we need not observe the “final lows” anytime soon. The problem is that even to get a sustainable “bear market rally,” somebody has to be convinced that stocks are desirable holdings for more than a quick bounce.
Probably the most important long-term risk to perceived valuations here is that the deleveraging pressure we’re observing is increasingly likely to cap future return-to-equity at a much lower level than was possible with extremely high levels of debt. This will make historical norms of price-to-book value and price-to-revenues increasingly relevant, while the recent history of peak-earnings (and perhaps even dividends) may be misleading because the recent peak in profit margins will be far more difficult to recover compared with past cycles. Again, I believe that stocks are undervalued, but not extremely so. Passive, long-term investors in the S&P 500 can reasonably expect average total returns moderately higher than 10% annually over the next say, 7-10 years, but there is a good chance that even these prospective returns are not high enough for value investors to make a firm stand.
The misguided policy response from Washington has focused almost exclusively on squandering public money and burdening our children with indebtedness in order to defend the bondholders of mismanaged financial institutions (blame Paulson and Geithner – I’ve got a lot of respect for our President, but he’s been sold a load of garbage by banking insiders). Meanwhile, I suspect that the little tapes in Bernanke’s head playing “we let the banks fail in the Great Depression” and “we let Lehman fail and look what happened” are so loud that he is making no distinction about the form of those failures. Simply letting an institution unravel is quite different from taking receivership, protecting the customers, keeping the institution intact, replacing management, properly taking the losses out of stockholder and bondholder capital, and issuing it back into private ownership at a later date. This is what it would mean for these banks to “fail.” Nobody is advocating an uncontrolled unraveling of major financial institutions or permanent nationalization as if we’ve suddenly become Venezuela.
The HCM Market Letter, written by Michael Lewitt, is a subscription service but John Mauldin was allowed to distribute a recent letter to his readers. It is a good read with thoughtful analysis. Some excerpts:
The Obama Administration is facing a near-impossible task trying to bail the U.S. economy out of the muck of years of ill-begotten economic policies. The biggest challenge facing policymakers is not short-term recovery, however. Eventually, stimulus is likely to arrest the forces of economic collapse and stabilize matters – at least temporarily. But the real problem is sowing the seeds of long-term, sustainable, organic economic growth. This is really the crux of the policy challenge. The United States in the midst of the worst economic downturn in 80 years as the result of a panoply of extremely poor economic policy choices. Economist Roger W. Garrison draws an important distinction between “healthy economic growth, which is saving-induced (and hence sustainable), and artificial booms, which are policy-induced (and hence unsustainable).”2 In other words, monetary policy that kept interest rates low for an extended period of time, tax policy that favored debt over equity, regulatory policy that allowed financial institutions to operate opaquely, and social policy that pushed home ownership regardless of affordability, all combined to create artificial economic demand that could only be financed with debt because the savings (i.e. equity) to purchase them did not exist.
Moreover, as more and more debt was created through financial engineering and policy prescription, the prices of these were bid up higher and higher. This led these products to become grossly inflated in value compared to any inherent economic worth they might possess. Once the bubble burst, their value dropped precipitously. Unfortunately, the face amount of the debt used to purchase these assets did not adjust downward at the same time. Assets that were purchased at inflated prices are now worth a fraction of what they were purchased for, leaving behind a serious dilemma for the owners of these assets and their creditors.
Following conventional economic thinking, the government believes that the solution lies in policies designed to reflate the value of these assets. The problem with this approach is that it is based on the incurrence of trillions of dollars of additional debt to create the demand needed to purchase these assets. Debt begetting more debt is a poor prescription for sustainable long-term economic growth. At best the government may be able to provide a short-term boost to the economy, but what the economy really needs is a solid, organic foundation for growth. Debt-financed government demand can’t be sustained indefinitely, which is why this policy is doomed to fail in the long run. The U.S. balance sheet is not a bottomless pit, although it is increasingly coming to resemble a Black Hole. At some point, the economy will have to generate sufficient tax revenue to pay for this government spending or the country will lose its AAA rating and ultimately become a troubled credit. Economic demand will ultimately have to become savings-driven or it will again collapse….
…A bear market rally is possible at any time. Investors should be aware that as the market moves lower, rallies have the potential to be extremely sharp since they are starting from compressed levels. Such rallies should be used to reduce overall equity exposure. That does not mean that equities should be abandoned totally. There are a number of stocks that are trading at well below book value (even taking into account the declining transfer value of their assets) that may be worth buying in the months ahead. The debt of these companies, which HCM is particularly active in, is even more compelling as an investment. But investors need to identify longer term changes in market behavior and the economic environment before becoming bullish again on stocks. Right now, there are no such signs, such as better employment, housing or GDP numbers, or tightening credit spreads, or improving market technicals. HCM is starting to sense that the forces of denial, as potent as they are, are starting to weaken. Accordingly, investors should structure their portfolios for further equity declines…
…HCM believes that after the stock market bottoms, it will drift along at a depressed level for an extended period of time. The American economy will experience less-than-trend growth for a similarly prolonged period of time. The economy will have to absorb trillions of dollars of bad debts and transition its resources away from speculative activities and toward new productive endeavors. The economy has to be completely retooled, and this process will not happen overnight, particularly because such a program must be directed by a highly inefficient democratic political system that is inefficient in reaching consensus about its goals and how to achieve them. Unfortunately, the deeper involvement of the government in the financial and other sectors of the economy is likely to stifle growth, innovation and creativity and further contribute to lower growth for years to come….
…The biggest problem with the budget – and with any budget, not just Mr. Obama’s – is that the government just wastes so much stinking money. The reason people find higher taxes abhorrent is not because they don’t want to help those less fortunate than themselves, or fund necessary government programs, but because they don’t want their money to be treated like Congress’s personal piggy bank. We would love to see the list of the $2 trillion of wasteful programs that Mr. Obama claimed his team has already identified for elimination. The amount of government waste is truly mindboggling, and Mr. Obama must insist on spending discipline if he is to have any chance to keep the budget deficit from exploding over the next four years.