Stocks Look Pricey

The first quarter of 2006 is over. Now is a good time to reflect on stock prices and the opportunities they present.

Bargains are scarce. Equities are expensive. In recent weeks, I’ve heard several fund managers say valuations are still attractive. I don’t agree. Generally speaking, valuations are unattractive. Returns on equity are higher than historical levels. A market-wide return on equity of 15% is unsustainable. Price-to-earnings ratios may not fully reflect how expensive stocks are. Price-to-book ratios are more alarming.

There are two additional concerns. Most discussions of the relative attractiveness of equities focus on the S&P 500 and forward earnings. The S&P 500 is not the most representative index. It may not be the best index to consider when looking at market-wide valuations.

Forward earnings are (necessarily) estimates. Where current returns on equity are unsustainable, projected earnings that use similar returns on equity may overstate the earnings power of equities in general. This can occur even where the estimates appear reasonable given current earnings. If you start with unsustainable base earnings, you are likely to overestimate future earnings even if you truly believe you are assuming very modest earnings growth.

Assets in general are pricey. Value investors have few places to turn if they continue to insist upon a true margin of safety.

Bonds are unattractive. Long-term inflation risks make U.S. treasury, corporate, and municipal bonds a fool’s bet. There is little to gain and much to lose. The know-nothing investor who buys a top-quality bond today and holds it for decades may very well find his purchasing power diminished.

There may be some select opportunities in foreign equities. But, these are difficult to evaluate. Foreign government obligations are also difficult to evaluate, but that isn’t much of a problem for value investors, because most foreign government debt is priced to perfection. You’ll have to be willing to take a lot of uncompensated risks if you want to own such bonds.

Of course, there are exceptions to every rule. There may be a few bonds out there that are attractive. There certainly are a few attractive stocks out there. But, even those stocks that look very attractive relative to their peers don’t look nearly as attractive when compared to past bargains.

Value investors face a difficult choice. They can assume stock prices will return to historical levels, and hold cash until the correction comes. Or, they can accept the reality they currently face.

There is no logical reason stock prices must necessarily return to historical levels. During the twentieth century, real after-tax returns in diversified groups of common stocks were very high relative to other investment opportunities. There have been various reasons given for why this occurred. Many have said these returns were possible, because of the higher risks involved in holding equities. Over the long-term, risks were somewhat higher than today’s investors seem to remember, but they were hardly severe enough to justify the kind of performance spreads that existed during much of the twentieth century.

True, if you bought at inopportune times, it was possible to remain in a fairly deep hole for a fairly long time. But, if you gave no real consideration to the timing of your purchases or the prospects of the underlying enterprises, you did better than many bondholders who chose their investments with the utmost care.

This is a disconcerting problem. It may be that most investors are overly sensitive to the risk of an immediate “paper” loss in nominal terms, and therefore overlook the much greater risk of a gradual loss of purchasing power. Issuing fixed dollar obligations may be the best bet for any business or government that seeks to swindle investors.

For the sake of the common stockholders, I hope many of the best businesses continue to issue such obligations when money is cheap. Corporate debt gets a bad name, because it tends to be overused by those who don’t need it and shouldn’t want it (and, of course, by those businesses that do need it but won't survive even if they get it). The businesses that would benefit the most from the use of debt usually appear to have more cash than they could ever need. But, it’s best to think ahead. For truly high quality businesses, the cost of capital will fluctuate far more wildly than the likely returns on capital.

If, during the last hundred years, stocks really were far cheaper than they should have been, is there any reason to believe stock prices will return to past levels? The past is often a pretty good predictor of the future – but, not always. It’s difficult to say whether, over the next few decades, valuations will, on average, be higher or lower than they are today. However, it isn’t all that difficult to say whether, at some point over the next few decades, valuations will be higher or lower than they are today. The answer to that question is almost certainly yes. They will be higher and they will be lower. Maybe for a few years or a few months. Maybe for a full decade. I don’t know.

What I do know is that value investors will have opportunities to make investments with a true margin of safety. But, should they wait?

That’s the most difficult question. Today, I am not finding opportunities that look particularly attractive when compared to the best opportunities of past years. But, I am still able to find a few (in fact, a very few) situations where the expected annual rate of return is greater than 15%.

That will be more than enough to beat the market. It will also likely be enough to provide a material increase in after-tax purchasing power. That’s not guaranteed, but it hardly seems holding cash would offer the better odds in this regard.

So, is an expected annual rate of return of 15% good enough? Is it reasonable to bet on the good opportunity that is currently available instead of waiting for the great opportunity that may yet become available?

I’ll leave that for you to decide.

Cyclic Stocks vs. Growth Stocks

In the long run the economic performance of most countries is showing an upward trend. But, although this is true, the global economy and that of individual countries is always subjected to ups and downs.
Many sectors are especially exposed to these up and down swings.
Building and construction companies, automobile companies or steel manufacturers are all hanging on the economy like a marionette on strings. Large profits are taking turns with setbacks or even huge losses during a recession.
And the shares of these companies and sectors are substantially affected by the up and down swing of the economy. When profits increase in good times, more often than not, these stocks skyrocket disproportionately. But when profits decrease, investors let go of these stocks as if they carry the plague.
OK. You might say that this ain't a problem. You just buy cyclic stocks when prices are down and sell when prices are up. By low and sell high!
But unfortunately the economy isn't quite that reliable. Especially not the stock market. If it was that easy to make money with stocks, lottery companies would all go out of business in no time.
There are all kinds of factors that can get in your way like wars, a financial and currency crisis like we had in Russia and Asia in the 90's. Or oil prices are giving us a hard time again.
So you can't tell with absolute precission when your stocks have reached the bottom just like you can't accurately tell when your stocks are at their very peak before the market corrects again.
A nice example for cyclic stocks are General Motors and Ford. The stocks of these 2 companies have performed so badly in the past that they were downgraded to junk status by the rating company Standard & Poors.
The headlines at marketwatch.com read this:
GM, Ford debt cuts take toll on stocks.S&P slashes automakers' credit ratings to junk status.
Shares of General Motors slid 5.9% while Ford shares fell 4.5% after Standard & Poor's cut its long- and short-term corporate credit ratings on GM and Ford to such a low level, that the word "junk status" was out faster than the 2 stocks fell that day.
But what can one expect if you look at the stock charts of these two corporations.
To view the charts, please click the following link: http://www.stockbreakthroughs.com/Newsletters/cyclic-vs-growth-stocks.htm
Holding on to these stocks makes no sense and is a waste of time and money!
Often the reallity with cyclic stocks is, that investors get in to their trade too late and also get out too late. The media is also to blame for this. When the word of an upswing is out, it's in full swing already. It hasn't just started. Buying then is senseless for an investor that speculates on buying low and selling high.
And when the headlines scream "Recession", the bottom of the valley has already been reached long ago. Selling now makes little sense because by now prices are in the red again.
Also with growth stocks there's no guarantee for the fast and easy buck!
But they have one huge advantage:
In the long run, their prices only point in one direction...UP!
The entry point for a long-term investor is by far not as important as with cyclic stocks. Setbacks are more seldom and, with few exceptions, also not so violent.
A stock like Johnson & Johnson (J&J) or General Electric (GE) is the perfect example for a strong and solid growth stock:
Again, just click http://www.stockbreakthroughs.com/Newsletters/cyclic-vs-growth-stocks.htm to view the charts.
The 3 dips in J&J's chart and the one in GE was only due to the overall global recession between 2000 and 2003 after the big "Internet Bubble" popped. But while most cyclic stocks are still at the bottom, J&J and GE have long been on their way up again.
These kind of stocks you can always buy without any second thoughts.
In my experience, cyclic stocks will lose you more money and cost you more nerves than you can ever make up for with a few lucky "cyclic" trades.
Yours in Successful Trading,Ricky Schmidt

Stock Market And Stock Exchange Basics - More Info To Help To Help You Master Stock Trading

Stock Market' as it is used in general conversation has taken on the meaning of both the business being conducted in investment markets and the physical place where most of the transactions are taking place. We can speak in broad terms about the Market being up or down and mean the general performance of many individual stock exchanges in the country, such as NYSE or Nasdaq in the United States. To use more specific language for where stocks are actually traded, the term 'Stock Exchange' is used.

Each company will generally trade its stock on one Exchange, unless the company is very large and, for example, trade in multiple countries. Each country may have several Exchanges where different companies are listed. As long as operating hours are obeyed, people around the world can trade in any country's Exchanges. Trading times are similar to, but slightly shorter than, a regular business day. Exchanges in New York are open from 9:30am to 4:00pm Eastern Time and other exchanges have similar trading hours in their local time zones. Japan, India, England, Germany, Switzerland, China, and the United States host the major world Stock Exchanges. Notable among these big players are the Tokyo Stock Exchange, Shanghai Stock Exchange, the Nasdaq, the NYSE, the AMEX, the London Stock Exchange, Frankfurt Stock Exchange, and the Bombay Stock Exchange.

Stock markets can be used as a barometer for economic health of a country. When production is high, unemployment is low, and inflation is low the market gains total value. This rise is a bull market. When stock prices start falling in a bear market, the economy is generally on a downturn. High inflation and high unemployment are usually seen at this time.

Changes in stock prices aren't entirely dictated by the health of the economy. A large part has to do with investor psychology and how it relates to changes in supply and demand. When one stock becomes a hot commodity, other investors try to join in and the price is driven ever higher. Conversely, if a number of people start to sell a stock and the price drops, others will try to sell before it drops more. This push to sell just drives down the price faster though. These psychologically driven market changes tend to be short lived and balance out in the long run. It is the economic health over time that is reflected in the long-term trends of the market.

Stocks are not the only place to invest though. Other major investment markets include Foreign Currency Exchange, Futures, and Options markets. Globally, the largest single segment of the investment sector is in Foreign Currency Exchange. Currency traders move very large sums of money between different currencies very quickly to take advantage of small fluctuations in the exchange rate. These trades usually are only owned for a day and are only profitable if the trader is very attentive to factors influencing the day's rates.

Futures Markets are designed to give buyers and sellers in volatile markets fixed prices at set times. The price for a quantity of goods is fixed in the contract, as is the time of the delivery. When the market then fluctuates, the locked in price for the contracted good means that the value of the contract itself changes. Traders in Futures are less interested in the price obtained in the contract for the goods, but are interested in the value of having that price fixed against the changing actual price of the goods.

The Options Market also deals with contracts for future prices. The difference from the Futures market is that Options allow the owner to buy at a specified price before the date given, but does not force the owner to buy that item. The Options themselves may be bought and sold, or used on a higher-risk investment as insurance. These investment tools have a high risk of loss. It requires a specialized knowledge of the option itself as well as the market it is trading in to make a profit. Most traders also benefit from having experience in a market. Stocks require less specialized knowledge to invest in with relative safety because the market as a whole changes more gradually than options on the market change. Stock traders can invest in certain ways intended to change the value of holdings very quickly, but the majority of investors put their long-term investments into stocks.

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