Hi Tim, I know just what you mean about buying levels being tough to identify... this article elaborates on it:
The Conundrum
06-Mar-01 01:42 ET
[BRIEFING.COM - Robert V. Green] A conundrum is a situation which appears to have no perceptible solution. Are we entering a new investment era where picking an investment is a "least of all evils" scenario? Here are some thoughts.
What's Happening
There are three major broad secular trends going on:
Return to traditional valuations for equities
The paydown of federal debt
The lowering of interest rates
Trend 1: The return to traditional values could mean low returns for equities for some years. For the Dow, it has already happened, with the last three years being basically flat. Even if we don't have a downturn in the economy, a reduction in the valuation metrics for stocks could mean difficult returns.
As an example, take the stalwarts of the economy. Cisco, like many technology stocks, doesn't look like a weak company at all. All that has happened is the incredibly high expectations of growth going forward have started to come down. Combined with the trend of lower valuations, the double-whammy has wrecked havoc on CSCO.
But there is nothing wrong with Cisco's business.
The difficulty here is that, even after the train wreck of 2000 for the market, many stocks are still valued very highly, by historical standards. The PE of the S&P 500 still stands at 25. In the week before the 1987 crash, the PE on the S&P500 was just 22. The most recent market low is 1980, when the S&P500 PE stood at 7.
If the market continues its trend towards the median of valuations, a company has to increase its business substantially to see total market cap growth. Public companies will have to "swim upstream," against the tide of lower metrics.
This downward valuation trend has been strongest in the technology sectors, but should certainly be watched in other sectors. So far, a return of the historical mean has only been hinted at across the broad market, but the possibility is very real.
Trend 2: The disappearance of government debt means no risk-free investment is possible. For someone with an objective of capital preservation, this is bad news.
After all, what better investment is there than a government bond? There is no risk of default. (If the US government defaults, forget it, all investments except gold will be threatened.)
And for the last 15 years these have been great deals, if purchased at the right time. There are undoubtedly some persons still holding 30 year US Treasuries that were issued in 1981 at 14%. Those holders still have ten more years of guaranteed 14% returns. It took courage to buy them in 1981, but buyers are still being rewarded, without any risk except inflation risk.
Last week, the last one year Treasury bill was issued. You can no longer buy one if you want one. As the government debt gets paid off, US Treasury bills and bonds would disappear completely. For baby boomers wanting secure dividend checks ten years from now, finding an appropriate investment could be a lot harder.
They would have to look at other types of bonds. But that brings us to the third trend.
Trend 3: A continual lowering of interest rates means one thing: Bond returns get weaker! Bonds have been pretty good investments for nearly ten years, because the real rate of return, the after-inflation return, has been at the historically high end of the range.
But as the Fed tries to stimulate the economy, rates are being lowered. What if the desired stimulus just doesn't happen? And rates continue to decline? And inflation rises? Bonds become less desirable.
The Condundrum
If stock returns are dropping, even as the businesses do well, and risk free US Treasuries are gone, and bond rates are falling, even as inflation rise, what is there that you can buy?
We aren't anywhere close, yet, to all of these trends reaching full strength.
But all three trends are real, have started, and are now building.
The Interim Solution
So what can you do, if you still want to save and accumulate wealth over the next ten years? Here are some thoughts.
First, recognize there are really only three types of investments: equities, bonds, and cash. So the first decision is how much of your portfolio should be allocated to each type of asset class.
Cash won't become king unless we have a severe depression. That isn't likely.
So you should still maintain a mix of mostly equities (stocks) and bonds. But the approach most likely to be successful over the next is probably not what worked in the past three years.
In the past three years, big bets on hot stocks are what worked. Momentum drove the market and if you could find and capture momentum early, you got rewarded. Sometimes in a big way.
In fact, owning a basket of hot stocks usually worked, because the one that took off paid for any other losses, but often the losers just stayed flat.
A better approach today for your stock portfolio is probably to mix very few stock investments, perhaps even just one, with stock mutual funds. The stock mutual funds will give you diversity and the exposure to the overall market.
The stocks you pick should be carefully selected. You should know just about everything you can about every stock you own. Casual purchases are likely to be punished. From now, it is work to invest in stocks. If you can't follow a stock closely, don't own it. If all you can follow is one, then own just one, and get diversity in funds.
Bonds, however, with reinvested income, will provide a buffer to lower stock returns, because the payment stream serves to offset declines in stock values.
And, if the return to traditional stock market trends takes over, then 10% annual returns will be considered good. A 10% return in 1999 was laughed at! But it is what everyone expected from stocks as little as eight years ago.
To achieve these types of investment mixes is difficult if you have less than twenty or thirty thousand dollars. In that case, mutual funds may be a good approach to obtain equity and bond positions.
Finally, continually adding to your savings portfolios, with contributions taken from your income stream, should be used. Known as dollar-cost averaging, it is probably the best approach to take when entering uncertain investment environments.
Well, Duh!
If all of these thoughts elicit a "Well, Duh!" response from you, you probably were raised on traditional approaches to the markets. The "interim solution" above is, in fact, the old-fashioned traditional approach to accumulating a nest-egg.
But there are a lot of investors around today, with years of investing ahead of them, for whom the traditional stock market is a brand new phenomenon that looks puzzling.
If you've been baffled lately, unsure of what to buy, take solace knowing you aren't alone in your conundrum. |
