Mohan, et al--I greatly appreciate this thread and the contributions of many of the participants, bull or bear. Like many, I am trying to figure out where things are headed, and wanting to be something more than a lurker, I thought I would offer a few of my humble thoughts on why we are where we are today and why I think that there is a distinct possibility that we are heading lower.
By all historical measures, to my knowledge, the market is overvalued. It has been overvalued for a number of years now, at least two anyway. One has to try to find anwers to the question of why this has remained the case. My answers are 1) globalization of markets; 2) increased competitiveness of US companies in the global arena; 3) baby boomer fear of the retirement years (social security and all that) and 4) rapid growth in many areas of the world, especially SE Asia. I'm sure that there are other reasons that fit into this picture. Rapid growth in corporate earnings, continuing expansion of the US economy without reemergence of inflationary pressures, technology boom, fall of the iron curtain, and the like come to mind. But these four factors, I think, are the principal ones that have stoked the fires of high valuations. IQBAL eloquently mentions factors like these, and I think he is right. This base of factors has been dubbed with such monikers as "the new paridigm" or "new era investing." A number of "old timer" analysts have never bought into the powerful thrust that these four forces have offered. They didn't recognize that the rules had changed, and they lost out on much of this upmove that began in earnest in 1995.
Now one of the legs of our table has been sawed off a little by the financial debacles in SE Asia that began in Thailand, spread quickly to Malaysia, Singapore, Indoenesia, and now Hong Kong. Forty to 50 percent drops are evident in most of these markets. So, we're off not a little, but a lot. The table is very wobbly and we might have to saw off some from the other legs to even it up. We have seen the repercussions on our markets in semiequipment manufacturers and electronic component manufacturers (ECMs) most recently and those downturns have dramatically affected the health of the tech sector, in particular, and the general market overall.
I don't think that it is over, IMHO. And that is because I think that valuations have increased to such high levels that they will have to back down to more historically reasonable ones. What is historically reasonable? I like to use the inverse of the long bond rate, which would give us about a 16-17 P/E ratio. This is far removed from the 22-23 P/E ratio that we have seen in recent months.
The US economy remains strong. Inflation has yet to accelerate and may, in fact, retreat from present levels of 2.5 percent or so. A large number of companies recently reported earnings that outpaced analysts estimates. The fundamentals are still strong for a vast majority of US companies. But the valuations? If these slide from current levels to even, say, 18, we are looking at about a 25 percent slide in prices. From the 8,000 level we recently enjoyed, this would take us back to 6,000. Overdoing it somewhat, which is always the case, we could slide to 5,500 or so.
In August, we started seeing some reevalation of the Cokes and P&Gs with concern that international growth would not support their valuations. This caused a dip in the DOW, but activity switched to the NAZDAQ. When that game played out, where else was there to go? In mid-September, if memory serves, the long bond was hovering around 6.6 percent. About one-half point has come off of that rate. The smart money is moving rapidly to safer havens. This money is coming out of the markets, and to some extent, may be coming from abroad. Maybe a large extent. This is a sizable move, occurring in a time when with the increasing evidence that the US economy may be showing signs of overheating we should expect the long bond to drift upward. The smart money has made its move, led by Warren Buffet.
Does this mean that the new paridigm is wrong? I think not. While the case for new era investing is still strong, the implementation certainly will be postponed. The long side will again be the place to be and be seen. But there is a lot of damage out there and it will have to be played out.
I, myself, am a trend follower. The air came out of US markets on October 16th and 17th, to be followed by additional deflations on the 23rd and 24th, not to mention the activity this week. That was enough for me; I sold. Yet, we are not going straight down any more than we went straight up. There will be wild gyrations in the mean time. It would take a lot of convincing to get me to believe that we will be heading dramatically upward anytime soon. Still, we have considerable damage to only one leg of the table, so nothing would surprise me. Okay, I admit that I would be surprised with a significant recovery. But, these days, who knows. And that's the point. When you get down to it, nobody knows. And this probably argues more than anything for being a long term, dollar-cost averaging, investor, rather than an in-and-outer like myself.
Best of luck to all in your investments and keep those informative posts coming. |
