By Bob Wood, MMNS
As I write this column on the last trading day of February, the Dow Jones Industrial Average sits slightly above the 7,000 level, down from 14,000 about 16 months ago, which now marks its record high. With such a devastating drop in the index, investors must be wondering if the markets are at or near bottom, since that normally presents a wonderful buying opportunity.
Are we there yet? I donâ€™t think so.
By the way, you should note that it took from 1900 for the Dow to go from the 66 level to the recent record high of about 14,300 in October of 2007. It took 16 months for half of those gains to be lost!
In normal times, big drops in stock prices, such as those seen now, would normally look like big discounts — the stuff of investor dreams. Past bear markets have produced subsequent recoveries in share prices that made such bottoms generational buying opportunities. So, naturally, we would love to think we are seeing one of those times now, especially in light of the damage done to investor portfolios in the 15 months since the last peak.
Investors are desperate for good news, hoping that all will be well and their life savings will recover to previous levels. Most wish they had acted to preserve that nest egg when they had the chance to do so. Ah, the wonders of hindsight!
Meanwhile, conforming to their usual habits, the financial media continue to seek ways to inspire investor confidence. Analysts use any possible bottom sighting to help generate more hope and optimism, assuring investors that â€œstaying the courseâ€ is only prudent. Yet each suspected bottom is met with more bad news, and then another new bottom forms. But this new bottom is touted once again as â€œthe one,â€ and with â€œSomeday we will all wish weâ€™d had the nerve to take full advantage of it.â€
Those foolish enough to follow the mediaâ€™s lead on these bottom calls then become emotionally invested in defending that view, which subjects them to more stinging losses as each dayâ€™s news fails to support their position. With an ounce of objectivity, they will have realized by now how the financial media have been dead wrong about the economy and the direction of share prices for this entire decade! Stock indexes like the S&P 500 and the Dow have fallen back to their levels from the summer of 1997. How many times will investors foolishly buy what those proven â€œmost wrongâ€ in their predictions continue to offer?
Shattering their fondest hopes is that steady stream of bad news arriving daily. Today we heard more negative news about the state of our economy: the GDP report shows a contraction of 6.2% for the last quarter of 2008. Remember back a year or so ago when Fed Chairman Bernanke assured us that we would certainly not dip into recessionary territory? Remember Larry Kudlowâ€™s exhortations about our â€˜â€™Goldilocks economyâ€™â€™? And how did their predictions work out?
Yet recent news items point not only to recession but borderline depression. The auto sector now estimates annual production for the current year at about nine million vehicles, down from around 16 million a couple years ago. That represents more than a small drop in economic activity, doesnâ€™t it?
We now see that more than five million Americans are collecting weekly unemployment checks — a new record high. And with retail sales falling by double digits in many sectors, any hope for new job creation looks dim.
And Itâ€™s not just about the U.S. that weâ€™re hearing and feeling the steady drum beat of bad news. This week, the Financial Times newspaper ran a story about the falling rate of exports from Japanese manufacturers. Their exports fell by over 45% in January from the same month a year ago, a huge drop representing the fastest decline in more than 50 years.
Another problem with that bit of news is that, contrary to what most of us think, America still remains a major exporter of manufactured goods, and exports are considered a sign of hope when domestic consumption slows as it has. But we canâ€™t count on exports alone to remedy our entire economic situation any time soon.
Perhaps just as confusing to U.S. investors is how stock prices still are not viewed as bargains, even after having fallen so far from their old highs. What they might be overlooking is how far corporate earnings have dropped in that time. Over the past four quarters, earnings for the companies comprising the S&P 500 have been battered by operating losses, which have compounded as a result of write-downs on assets.
Earnings for the basket of shares making up that index have fallen to about $30, which means that, at todayâ€™s 750 value for that index, its P/E has actually risen to about 25! That surely is not the sign of a bottom, since secular bear markets tend to end with valuations in the high single digits. We are far from that now, and with earnings continuing to deteriorate, falling share prices are met with rising P/Es.
Also making the recovery to their old earnings even harder for big companies is how far their pension plan assets have fallen in this bear cycle. Retailers such as Sears Holdings and Macyâ€™s have reported that they will be forced to add millions to what are now â€œdangerously under-funded plansâ€ with falling assets and rising liabilities. And this situation will repeat each year until their pool of retirees begins to decrease. That dynamic will prove a real drag to earnings for many of our larger companies.
Such pension headaches extend to state and local governments, which are also victims of the 50% fall in share prices. Many of them were large shareholders in our biggest financial companies, many whose share prices either have been massively lowered or wiped out. These employers will need to choose between repudiating those benefits or raising taxes, and neither of those options bode well for future economic activity. Falling share prices seem to foretell more falling share prices.
This steady down-spiral of share prices and news of stalling economic activity, in my opinion, will not find their bottoms until our housing and job markets recover. With new home inventories at an all time high level and now showing a 13-monthsâ€™ supply, that news isnâ€™t getting better!.
When you add to that data numbers for record job losses cited in the form of new jobless claims and then actual monthly job losses, which are also hitting new records, looking for a bottom seems to become a wishful exercise. And donâ€™t we all know that wishing wonâ€™t make it so.
The bottom could be a long way off, potentially dropping another 25 or 30% . But even that is just a guess. The most bearish forecasts see the Dow bottoming at around the 3,000 mark. That estimate would be easier to discount if it werenâ€™t coming from those realists who have correctly predicted the economy and stock market performance over the past couple years.
Have a great week.
Bob Wood ChFC, CLU Yusuf Kadiwala. Registered Investment Advisors, KMA, Inc., firstname.lastname@example.org.