Graham’s premise (which he did not abandon even during the great depression) was that sooner or later the markets will reflect underlying corporate valuations. Therefore, long-term investors had a “basic advantage” over other investors, because they could ride out the tough markets rather than be panicked into buying or selling.
While stock markets periodically make dramatic swings up and down the earning power of the U.S. economy endures (with fluctuations). As Roger Lowenstein phrased it recently in the New York Times Magazine, “The people who chased unrealistic returns at the top, like those who are selling now, have simply cashiered their “advantage” to play a game that more nearly resembles Bernie Madoff’s.”
Therefore, it is with a heightened sense of perspective that we review the recent past and share our investment view for the future.
Great Depression II? We think not. The U.S. economy is experiencing what appears to be its deepest secular recession since the mid 1970’s and it may take a few more quarters for the economy and consumers to deleverage and turn the supertanker that is our economy around. In spite of this there are some bright spots for the upcoming year:
> The corporate sector is in relatively good shape with low debt and inventories
> Energy prices are down significantly with gasoline prices cut in half, now that the speculators are out of the market (good for consumer confidence and boosts disposable income)
> When aggregate demand for goods is insufficient, the solution is for the government to provide demand when the private sector will not – JM Keynes and Paul Samuelson (Recently signed into law by the new administration.)
Although stocks may weaken a bit further, for the long-term investor, many stocks are priced to deliver attractive returns. The ValueLine Survey estimates the appreciation potential of the broad market to be over 25 percent annually on average for the next five years. The current S&P 500 price to earnings ratio, commonly referred to as the P/E ratio, is currently just over 11X, while the P/E ratio of the S&P 500 over the last 25 years has been about 18X earnings. Therefore, if appropriate with your investment objectives take advantage of the relatively inexpensive stock market. We suggest adding high quality, dividend paying stocks or low cost, no load funds with that objective. The current yield on these funds averages about 5 percent, it’s like starting a 100 yard dash on the 50 yard mark, given that large cap stocks returned on average about 10 percent annually over the last 70 years. Investment income, whether from dividends or interest provides a cushion in down markets and many top-quality stocks have higher yields than the 30-year Treasury and appreciation potential.
Christopher Blakely
Sources: Goldman Sachs, Standard & Poor’s, The New York Times, Bloomberg LP, ValueLine
