Daily Comment - A Weekly Summary - Don't Be Fooled Again
10/10/02 5:00 PM
In our view today’s rally is just another temporary bounce that is more indicative of latent bullishness rather than the doom and gloom more typical of true market bottoms. This rush to get back in at any little glimmer of hope serves only to put off the eventual capitulation that is most likely in store. The market remains highly overvalued while the economy is threatening to go into another recession. Even if it doesn’t, the recovery is so anemic it’s hard to tell the difference. For some time now we have been saying that the strength in consumer spending would probably come to halt before corporate capital spending kicked in, and that seems to be happening now. Retail sales appear to have fallen off a cliff in mid-September after looking somewhat tepid in the back-to-school season just before and after Labor Day. Auto sales have apparently slowed down too. All of this does not augur well for the coming holiday season. Most of the earnings warnings have been announced and now, as usual, companies will report that they beat their substantially reduced estimates by a penny or two. The way the economy is shaping up, however, a lot of these companies will probably have some negative comments about the fourth quarter that will temper any minor upside third quarter surprises. All in all, we believe that the coming weakness in the economy will lead to further downward revisions and a continuing downtrending market.
Our Position On Gold
10/09/02 7:00 PM
Since a large number of bears are bullish on gold and Comstock has, in the past, owned gold shares we often get asked about our position on this precious metal. We believe that the best time to invest in gold for a major cyclical or secular move is prior to a period of significant inflation in the price of goods and services. During such a period fiat currencies lose significant value in relation to such goods and services, and gold provides a means of maintaining or increasing purchasing power. This is particularly true when stocks and bonds are also declining, as they most often do during the inflationary period. Some obsevers believe that gold is a hedge in a deflationary recession as well, although this is less clear. They point to the steep rise in gold during the 1930s depression as a case in point. We believe ,however, that some special circumstances contributed to gold’s climb during the depression. First, the price of gold had been fixed to the US dollar for many years and was therefore artificially repressed. The pressures then became so great that the US was forced to raise the fixed price substantially. Second, with no Federal deposit insurance in existance at the time, a series of bank runs caused great financial losses among ordinary depositors and led to a general mistrust of paper currencies. Neither of those circumstnaces prevail today. The gold price was unpegged from the dollar in 1971, and deposit insurance guarantees the safety of deposits. If anything, during a period of deflation, currencies buy more goods per unit and therefore become more valuable. Having said that, we still think there is a possibility that gold could rise as a result of either geopolitical turmoil, a bear market in equities, a weak dollar or a convergence of all of these factors. However, this is not as favorable for gold as the inflation case, as in a deflationary period a weak dollar will be offset by a stronger currency such as the Euro, which would then be an investment alternative. Another consideration is that, in the past, final stock market capitulations on the downside have often carried gold shares down as well. We missed this year’s rise in gold and then decided to sit it out rather than join the crowd on the spike. Since gold peaked in late June it has not been acting well despite the threat of war in Iraq and the continuing terrorist threat. At the moment we have no position in gold, but remain agnostic on the outlook. We are open minded on the subject and could change our minds at any time. If we do, we’ll let you know.
Economy Weak Prior To Port Stoppage
10/08/02 5:30 PM
So now it’s the prospective end of the West Coast port stoppage that’s going to end the bear market. Since the early 2000 market peak this bear market has been attributed to everything including the disputed 2000 presidential results, the September 11 attack, erroneous Fed monetary tightening, the weather, corporate malfeasance and a dozen other non-related items. Excuse us. We just didn’t know the bear market of the last two and a half years was in anticipation of a port stoppage, and that once this dispute was ended, the market would continue upward on its merry way. What investors, economists and strategists find difficult to concede is that this bear market is a result of the late 1990s financial and economic bubble and its aftermath. The market remains overvalued, the economy is threatening to double dip, public participation is near record highs and sentiment remains too optimistic. Until the structural imbalances in the economy are corrected and market valuations become more reasonable the bear market will continue, albeit interrupted by deceiving rallies. In our view the economy, including consumer spending, was weakening prior to the port closures. The dispute may cause further weakness, and may be used as an excuse for any economic softening that occurs in the period ahead. Since the ports have already been closed for ten days, the effects of the shutdown will probably obscure the meaning of the economic numbers for a couple of months. When this happens, just remember that the economic numbers and corporate earnings estimates were already coming down while the ports were still open. In fact, it is entirely possible that the second and third quarters of the year were artificially inflated by pre-ordering of goods in anticipation of the potential stoppage. Whatever the case, we think that the underpinnings of the economy are far weaker than the consensus believes and that this has yet to be factored into stock prices.
P/E Ratios: Why the Differences?
10/07/02 5:30 PM
Despite everything we’ve written on the subject, readers are still confused by the difference between the high market P/Es we keep talking about and the low P/Es they see mentioned in the media. We thought that by now you would be bored with the repetition, but we’ll take another crack at the topic and try to make the differences as clear as possible. The difference between those who assert that P/Es are high and those who believe that they are low come down to the treatment of two items. First, in making the P/E calculation we can use either reported or operating earnings. Second, we can use either trailing four-quarter actual earnings or estimated year-ahead earnings. At Comstock we use reported earnings for the trailing four quarters. Until the mid-1980s reported earnings were the only earnings. Operating earnings are a gimmick used to inflate reported earnings by excluding expenses that corporations arbitrarily choose to eliminate. As for estimated forward-looking earnings, these are almost always wrong on the high side, and most often by wide margins. In doing the calculation we divide the present S&P 500 of 785 by $30 of earnings for the four quarters ended September 30, 2002 and come up with a P/E of 26, compared to long-term historical average of 15.5. Many of the people you see or hear in the media use estimated 2003 operating earnings of $58 and get a P/E of 13.5. The $58 number is operating earnings and is most likely far too high. In our view this method is equivalent to rolling back the odometer on a used car. Keep in mind, too, that had operating earnings been used throughout history, the historical average P/E would be far lower than 15.5. In response to the confusion Standard & Poor’s has proposed a new figure called “core earnings” that will fall somewhere in between reported and operating earnings. They expect to publish historical numbers for this series in a short time. For more detail on this see Standard & Poor’s white paper called “Measures of Corporate Earnings” at www.spglobal.com/releases/MeasuringCorpEarnings.pfd.
A Mid-September Economic Downdraft
10/04/02 6:30 PM
Today's employment report for September could have been worse, but it did nothing to dispel the idea that the economic recovery is dead in its tracks. Payroll employment was down for the first time since April, although the August number was revised sharply upward. Although unemployment was down, the figure doesn't make any sense in view of the lower employment payroll number and the high level of initial unemployment claims. The unemployment report is based on a relatively small sample and is subject to unexplainable month-to-month fluctuations, while the initial claims number is based on an actual count from each state. When combined with other reports such as the low level of help-wanted ads, it is apparent that the labor markets are quite weak. Overall, payroll employment has dropped 17,000 since January, not what you would expect in a recovery. Although the economy has given indications of faltering for some time, a few anecdotal stories strongly hint that a sharper downturn may have occurred in mid-September. EMC management stated that, "The IT spending environment continues to be brutal. In fact, it got even worse at the very end of the quarter. Our third quarter was on track until late September." On the consumer side, specialty retailer Aeropostale said, "In mid-September, however, we began to see a significant reduction in our sales activity." This view is strongly supported by statements from a large number of representative retailers that indicated their sales have weakened considerably. Further supporting the weak economy case, First Call is now reporting that analysts, on average, are now looking for third quarter earnings growth of only 5.9%, down from 17% on July 1. The percentage has been plunging from week to week under a barrage of continuous downward revisions. At a White Sulphur Springs meeting, leading corporate CEOs indicated they felt the recovery has stalled. Only 29% thought that business conditions now were better than they were six months earlier, compared to 62% who thought so one quarter ago. Foreign economies are slowing down in similar fashion, and this is being reflected in their stock markets. The French CAC 40 is down 41% year-to-date, the German DAX, 49%, and the British FTSE 100, 27%. Economies and stock markets throughout the globe, including Japan, non-Japan Asia and Latin America are also under severe strain. In our view the US stock market is highly overvalued even if a strong economic recovery is imminent. In the absence of such a recovery the degree of overvaluation is even more dangerous, and we fear that a further severe market contraction is ahead as the extent of the economic weakness becomes more apparent.
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