But that is only the first part of the analysis. To believe that stocks are cheap or at least reasonably priced based on the P-E ratio, the investor has to believe that the 'E' is stable or will rise. A stock with a low P-E ratio is not a good deal if earnings continue to decline, pulling the price down as well. The same holds true for the stock market as a whole. One rule that holds up well is stock prices decline more than earnings until near a bear market bottom when investors decide earnings are about to turn around. Sector and Balanced Managed Portfolios We benefited from quite a climb in Hussman Strategic Growth since the end of May. The fund increased almost 7% while the S&P 500 declined about 10%. For the year, the fund is up about 5% while the market index lost about 12%. Though the fund has been fully hedged against a market decline, it is interesting that the fund appreciated while the index was recovering from its July lows. Manager John Hussman became extremely bearish as the market bounced off the July lows. In an August 11 Weekly Market Comment Hussman said the fund had "a strong defensive position" and that "current market conditions warrant unusually strong concern." HSGFX anchored these portfolios the last few years, because of its ability to hedge or leverage its stock portfolio against the indexes. We have earned higher returns than not only the stock indexes but also than money market funds and even most bond funds. HSGFX delivered the return with far less volatility than the alternatives other than money market funds. Income and Income Growth Managed Portfolios The first rule of income investing is to ensure that the principal is safe. Many investors overlooked that rule the last few years, seeking higher yields in assets that carried risk of loss of principal. They saw principal dwindle in high yield bonds, ultra-short bond funds heavily invested in mortgage securities, and auction-rate preferred stock, among others. The next big surprise for income investors likely will be dividend cuts. Some prominent firms already have reduced or eliminated their dividends, but more cuts are likely to come. Dividend plays are tempting. Some stock prices have declined so much that their dividend yields are substantially higher than those available from treasury bonds, corporate bonds, and even preferred stock. SunTrust Bank yields over 7%. Citigroup is at 7%. Merrill Lynch is 5.3%. The list goes on, and the yields are tempting. Earnings generally have been declining for about four quarters. Some analysts like to take out the financial sector and point out that earnings have grown at a healthy rate for the rest of the S&P 500. There is another way to play that game. Take out energy companies also, and overall earnings growth is back to being flat or growing very slowly. There are more conservative approaches. One is to use the 10-year rolling average of earnings instead of the latest earnings or forecasts. Another approach is to use peak earnings for the S&P 500. By either of those measures, stocks are not cheap. Most well-known value investors are not buying U.S. stocks except with great selectivity. Some continue to hold high cash balances and put part of that cash to work each time the markets reach the bottom of the trading range they have been in this year. As I've said in past visits and in my book, Invest Like a Fox…Not Like a Hedgehog, it is not a good idea to use one piece of data to make investment decisions. The P-E ratio is an easy-to-find piece of data that has some uses, but it does not do a good job of indicating market turning points. We need to look at a range of data and the details of the economy. Right now, this big picture approach does not reveal a margin of safety in U.S. stocks.
© 2003 - 2010 Retirement Watch, L.L.C.
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