Bulling Through the Bear Brigade
P-E Ratios Show Attractive Buys Are Out There, Despite Widespread Pessimism
washingtonpost.com
By Chet Currier
Bloomberg News
Sunday, August 20, 2006; Page F04
Gloom is busting out all over.
War, terrorist plots, high gasoline prices and talk of a housing-led recession all feed into a dismal mood in U.S. public opinion forums, including the polls and the financial markets.
According to the latest Bloomberg News-Los Angeles Times poll, a great preponderance of the U.S. populace thinks the country is going in the wrong direction. "We are heading for a major contraction," a reader e-mails me.
Neither the stock market nor the bond market offers much to get enthusiastic about. Well past the halfway point of 2006, the 9,000-plus stock and bond mutual funds tracked by Bloomberg showed an average year-to-date return of 2.3 percent as of the end of last week.
Stock funds are up 2.3 percent, bond funds 2.2 percent. Vanguard Group reports that its four taxable money-market funds returned 2.6 percent to 2.8 percent from Jan. 1 to mid-August. It's an asset allocator's nightmare, with each of the major classes of investments producing the same dreary result.
A lone consoling thought presents itself: These mood swings often go to unwarranted extremes. Although the future can never be known for certain, this rampant pessimism may have created better buying opportunities in stocks than would have existed otherwise.
"It seems to me the alarmists are a bit too hysterical and ideological," wrote Edward Yardeni, chief investment strategist at fund management company Oak Associates Ltd., in a recent commentary. "They almost seem to be rooting for a recession."
In any good two-sides-of-the-story market, there is always a constituency for a decline in prices. Its most obvious members would be short-sellers, who have sold in hopes of buying back later at lower prices. It also includes those who have lightened up their long positions and accumulated cash reserves, holding out for better prices at which to buy.
This bear brigade has been enlarged by the rise of hedge funds, which at an estimated $1.2 trillion in total assets have more than doubled in size in the past five years. While hedge funds pursue all sorts of investment strategies, in the aggregate they are much more inclined to play the short side of markets than, say, conventional mutual funds.
No question about it, shorts can be a disruptive force at times. But long-term investors might welcome their presence, rather than deplore it. If everybody's a bull, no buyer is ever going to get a bargain.
One simple gauge of sentiment in the stock market is the price-to-earnings ratio, which displays in a single number how much investors are willing to pay per dollar of current earning power. The P-E multiple of the Standard & Poor's 500-stock index has been cut in half in the past four years, from almost 35 to less than 17.
According to my Bloomberg data, the P-E ratio of a leading international yardstick, the Morgan Stanley Capital International EAFE Index, is even lower, at 15 times the most recent 12 months' earnings. For the MSCI emerging markets index, the P-E has lately hovered around 13.
Plainly, one number can never tell the whole story. But anytime I'm thinking about buying stocks, I'll naturally prefer to pay less per unit of earnings rather than more.
Over the past 36 years, says Milton Ezrati, senior economic strategist at mutual fund management company Lord Abbett & Co., you could have done pretty well buying foreign stocks when their P-Es were lower than those of U.S. equities, and emphasizing U.S. shares when the domestic market offered the lower P-Es.
"Foreign stocks outperformed American stocks when P-E multiples abroad were lower," Ezrati says. "When in the late 1980s foreign multiples began to rise relative to those in the United States, the relative performance of foreign markets began to peak. The relative underperformance of foreign stocks only began to stabilize after 2000, when the relative attractiveness of foreign multiples reemerged."
Using this kind of "simplistic gauge," Ezrati acknowledges, no one should expect it to track "every wiggle in relative market movements." But the patterns do support a basic contrarian point: There's an enduring case to be made for thinking about buying stocks wherever and whenever pessimism prevails.
Chet Currier is a Bloomberg News columnist. |
