Ben Graham on market valuation, 1959:
"The record shows that declines have tended to be roughly proportional to the previous advances..."
Experience gives us another measure of the possible bear-market decline. This measure is based on the principle that the higher the market advance above a computed normal, the further it is likely to decline below such normal..."
[Graham's calculation of the "normal" today would probably be about 4000 on the Dow, maybe lower, given my reading of his writings. My own financial calculation of the "normal" is about 6000. Sounds crazy, right? Read the next Graham passage, and then tell me how crazy that sounds, given that I may be what he calls "the most conservative observer".]
"There is a paradox in this economic law which makes it virtually impossible for it to find acceptance in practice. For the almost universal optimism that accompanies the great advances in the stock market precludes even the most conservative observer from imagining a decline so drastic as these figures illustrate."
The keynote of course is optimism. We are enthusiastic about business prospects for the next decade...Hedodotus recounts a sayng of Solon the Wise that rich King Croesus sadly recalled before his execution - namely, that no man's life should be accounted a happy one until it is over. Perhaps the more prudent time to characterize the 1960s [the following decade] would be when they are over rather than when they have just begun."
[And what did Ben Graham think was ominous? He pointed out three market levels that had proven to be peaks, one of them an historical catastrophe that shaped his thinking forever.]
1929 High P/E 19.4 Yield 3.2% Bond Yield 5%
1937 High P/E 17.3 Yield 4.2% Bond Yield 2%
1946 High P/E 15.9 Yield 3.6% Bond Yield 3%
Today P/E ~27 Yield ~1.3% Bond Yield 6%
I'm sure Graham was called irrelevant in 1970 just like he is today. But the market P/E fell below 10 even in those "modern" times. Call me paranoid, but this stuff concerns me, to put it lightly. Warren Buffett obliquely said the same thing in Fortune magazine last week and nobody seems to have paid any attention to him. If you study your history, you will find that Buffett makes market calls only when things are at an absolute extreme. I count three in his entire career. 1) Liquidating his partnership in 1969. He was a few years early, but absolutely right. 2) Buying like crazy in 1974 - that was when he said "I feel like an oversexed man in a whorehouse" and "this it the time to get rich". and 3) Now. He's been telling us with increasing conviction for the last three years that he is concerned. I have never seen it laid out so compellingly as in the Fortune article.
Does this tell me to sell everything? Graham faced a similar question in the early 1970s when he saw the two-tiered market we see today. He said focus on the stocks themselves and what they're worth if the indices reflect the first tier of the market and you can fish in that second tier. I have pruned my portfolio down to net-nets and stocks that I have total conviction that their value is 50% north of where they are trading, plus a good deal of cash. But other portfolios I manage demand to be in "institutional quality" investments. Be careful what you wish for, because you might get it. "Institutional quality" has always turned out to be an oxymoron in the end.
I don't know when its going to happen, but I know its going to happen. I'd like to think that if I own real absolute value stocks it won't matter if the big indexes drop 50%. But that might be wishful thinking.
This is not "Jim's semiannual market call" - it is only reiterating the one I made in August. I am still very very bearish - and the more speculative the market gets (this week was truly scary), the more bearish I get.
Graham quotes from The Rediscovered Benjamin Graham, edited by Janet Lowe. The book is great. If you can get one of Amazon's coupons, please order it from them - I'm short the stock. Add a few bucks to their losses for me.
JJC |
