By Bob Wood, MMNS
Weâ€™re hearing lies again! Itâ€™s just as simple and nasty as that. Perhaps we should always hold that thought as the default assumption when listening to reporters in the financial media or someone employed by one of the big brokers. Paying heed to what they offer most likely goes against our own self interests and goes towards fulfilling theirs alone.
One reason often used as justification for buying stocks in one of the worldâ€™s most over-valued markets, the U.S domestic stock market, is the familiar refrain: â€˜â€™stocks are cheap,â€™â€™ and that determination is based on whatever valuation metric seems to fit the dayâ€™s premise. Wall Street does a great job of at using metrics that favor its premise, regardless of whether valuations are truly cheap or mighty expensive.
Lately, weâ€™ve been hearing that stocks are cheap based on forward-earnings estimates. Forward earning are just that –estimates, and weâ€™ve been hearing that hoopla for the past few years. But then, what good would it do stock and mutual fund sellers to admit that stocks are expensive based on real-world ways of measuring them?
Stocks and funds must be marketed and sold, so, logically, advertising them as â€œcheapâ€ works much better than admitting they are expensive now but might get even more pricy over time. So the master sales people simply begin with their premise and then work the statistics and other rationale to fit it. Thus, we hear again and again that stocks are cheap, based mainly, now, on those forward-earnings estimates.
One problem with using forward estimates is that you are investing based on someone elseâ€™s best guess as to how high earnings will go in the future. But how good has the Wall Street record been for predicting earnings in recent quarters? Letâ€™s remember that those leading financial firms missed forecasting almost entirely the housing and mortgage market crises and the resulting hits to earnings.
How many of them anticipated the steep drop in earnings for big Dow components like G.M., Citigroup and AIG earlier this year, while continuing to promote those stocks based on forward earnings from last year or the year before? Those large companysâ€™ earnings have been hit so badly that the Dow Jones Industrial Average no longer has a usable P/E multiple!
Perhaps the worst reason for using specious earnings estimates is extrapolating them into an average-forward earnings estimate. We now hear that the S&P 500 sells at a â€˜â€™reasonable 15 times forward earnings and, while not exactly cheap, itâ€™s not all that expensive either.â€™â€™
But we heard that last year, too, so wouldnâ€™t you expect, with the marketâ€™s dropping since last October, the average P/E for those stocks would be about 13 or 14? However, in the latest edition of Barrons, the average P/E for the S&P 500 is listed at 25!
If these assertions about forward earnings estimates were right over the past few years, when are we going to see the markets sell at the average valuations weâ€™ve been promised? How long can these promoters continue to tell us year after year that the market is cheap based on such flawed assumptions regarding corporate profits? Do they assume that investors will never catch on?
Another lie that is becoming embarrassingly hard to pitch is that the stock market is the way to get rich for anyone with available capital to deploy. Again and again, I ask people how many investors they know who became wealthy by investing in stocks. Each time, I get answers that Wall Street would not want to hear.
And now, with the implosion of the mortgage market and the â€˜â€™financial innovationsâ€™â€™ that Alan Greenspan promoted so highly as Chairman of the Federal Reserve – when this current mess was constructed, even the brokers themselves are going bust! Remember the venerable Bear Stearns?
Have you looked at performance charts for other large financial firms like Citigroup, Merrill Lynch, Lehman Brothers and others? Not good! If those players canâ€™t make money in the markets for themselves, how are they going to make money for their clients?
Some well regarded analysts are whispering that the basic business model for big brokers and investment banks is broken and that many of them will soon fail. Those who will survive are rapidly diluting the value of their shares held by investors by raising capital to offset billions of dollars in losses from their internal operations.
The staggering losses are being painfully endured by shareholders of the biggest and oldest financial firms in the country. Arenâ€™t these the same financial leaders who would lead us down the royal road to stock market riches?
So far, these and other financial firms around the world have admitted to losing about $500 billion, with credible estimates from analysts like Nouriel Roubini suggesting that far greater losses are yet to come. And this does not include the billions of dollars in mortgage losses now being felt at Fannie and Freddie, the two largest buyers of those products!
How many times have you heard that stocks have never endured a 10-year period of losses in the modern history of our U.S. markets? Yet, we now can see that over the past 10 years, our markets have gone nowhere! And since most investors do not beat the market over time, what can be assumed about true investor performance over that time?
That the stock market has garnered investors nothing in the past 10 years shows only the nominal performance of the major averages. But with inflation rapidly accelerating, the loss in real terms flies in the face of those assertions that investors who hang in for the long haul will invariably be rewarded.
How many times in the past couple of years have we heard that we are nearing a bottom in housing problems, only to see further deterioration? Even leading home builders are saying they donâ€™t foresee an end of their troubles any time soon.
How many times have we heard from leaders like Hank Paulson or Ben Bernanke that the subprime mortgage mess would be â€œcontainedâ€ and do only minimal damage to the overall economy? How many times has Bernanke testified before a Congressional panel or committee, explaining that he sees inflation moderating in the coming fiscal quarters. Meanwhile, during the past week, we heard the highest inflation figures in the past 17 years!
How many times has President Bush told us what great work his administration is doing on fiscal policy and how the Federal budget deficit is on track to become balanced–with no deficit projected in another five years or so? But last month, the federal budget deficit hit an all-time high for one month, over $100 billion. Oh, and Congress raised the national debt ceiling, again, by a not-so-inconsequential amount, $800 billion. If Bush and team are doing such a wonderful job, why such massive borrowing?
We also heard in past years that the falling dollar was good since it boosts exports and helps bring down our messy trade deficits. But the dollar has been tanking for the past six years, and the trade deficit is still setting new records each year!
Are you getting my drift? Weâ€™re being led down the path to financial ruin, and all the while, our leaders in Washington and on Wall Street are telling us to expect nothing but good times ahead. The big brokers promise us expert advice on all things financial while they themselves are blowing up on whatever theyâ€™ve been selling.
And once again, investor losses are piling up, and we see this stacking up as the lost decade for investors. But then, when have investors profited over the long term in stocks? That â€˜â€™stocks-for-the-long-run â€˜â€™ premise may be the biggest lie of all.
Have a great week.
Bob Wood ChFC, CLU Yusuf Kadiwala. Registered Investment Advisors, KMA, Inc., email@example.com.