The latest from Ben Stein:
Reality Test
Stock Shopping? The Market's Not Much of a Bargain Bin
By Ben Stein
Special to TheStreet.com
Long ago, I had a smart friend named Marvin, who passed along two pieces of wisdom. One was in connection with asking out a girl when I was shy. He told me, "No one has ever been killed over the telephone." Of course, neither of us knew anything about margin calls in those days, but otherwise it was great advice. His second bon mot was about playing golf. "In golf," he liked to say, "it's not about how. It's about how many."
This rings in my ears lately as I look at the deteriorating profit picture contrasted with the buoyant stock market and the stunningly pessimistic (about inflation) bond market. I also get angry letters from RealMoney readers who insist that my pessimism about stocks is misplaced, that profits are in a temporary slump and that a substantial rebound in earnings is imminent.
Magnitude Matters
To which I say, it's not about direction. It's about magnitude of direction. Or, as Marvin would have said, "It's not about how. It's about how many."
I don't doubt that the recession will end. I don't doubt that profits will rebound. In fact, not only will they come back, but I expect them to come back by a lot by the end of 2002, maybe sooner.
But by how much will they come back? Do stock prices discount a rate of recovery that is totally unrealistic? Very possibly. As of Friday, according to Barron's, the S&P 500 was trading at not 30, but at more than 40 times earnings. True, this is partly because of a certain huge loss at a certain huge energy-trading company. But for whatever reason, the S&P is now at more than 40 times earnings. This hasn't happened since 1933. This means that for the market as a whole, the price of a share that offers a dollar of earnings is about $40, more or less.
Suppose profits spring back like a cobra about to strike on short-sellers. Suppose profits go up by 50% in the next three years after the recovery starts, or, in other words, by 2005. That would mean -- if there were not 1 cent of gain in stock prices -- that the market would be trading at 27 times earnings. The market would be yielding 3.7% -- after an almost historically unique gain in earnings.
But the 10-year Treasury is already yielding about 5.15%, or close to 45% more than what the market would be yielding after that giant hypothetical profit rebound. Long-term, top-grade corporates are already yielding close to 7%, or nearly twice what stocks would be yielding after that immense (again, only hoped-for at this point) profit snapback. Does anyone think that bonds will be yielding less than 8% if the economy picks up to the extent I suggest? Then the difference in yield will be astronomical between the stock market and the bond market.
(The Dow Jones Industrial Average is selling at about 27 times earnings, so it's yielding about 3.7%. If profits went up by 50% in five years, it would be selling at about 18 times earnings, yielding about 5.6%, which is still a great deal less than the bond rate would be in such a recovery, but not as insane as the larger market picture. It would be selling at 18 times earnings in 2005 if there were not one penny of growth in stock prices.)
Pricing In a Rebound
Now, please note: I don't question that a profits rebound is likely, nay, certain. But a profits rebound for five to 10 years is already in the price today. It will take five to 10 years of great profits for the market to come up with something like the bond yield. And all the while, bondholders (of short-term bonds without much capital risk) will be getting a big fat cash yield premium over stocks quarter by quarter that compounds in a lovely way. (Stocks are yielding about 1.5% in dividends now.)
In my model, stocks will not have moved up one penny and will still be overpriced for at least the next several years by historical standards of stock- and bond-yield comparisons. That is, buyers of stocks now are buying something that is overpriced by a lot, even in the rosiest possible recovery scenario, at least if history is a guide, with little room for price rises except on a bubble basis.
I admit freely that there are many people with far greater day-by-day experience in the market than I have. God bless them. But my research suggests that you'd have to look in remote kingdoms for a time period when stocks started out at such a yield discount to bonds and went on to outperform bonds for the next five years. There may be such times, but I've had a devil of a time finding them.
Again, I don't predict prices, but history is saying we're in highly unfamiliar territory, with a long drop possibly ahead of us. |
