Revisiting 2009: Preserving Wealth and Creating Wealth

Investors have very different needs and concerns.  Broadly speaking, I classify people between those more interested in preserving wealth and those trying to build wealth.  There are other considerations, but that is a good place to start.

Many investors of both stripes now wish they had bought the market in the Spring of 2009.  As stocks rallied, there were three distinct choices:

1. You could decide that you had "missed the bottom."  This meant that you would sit on the sidelines, perhaps forever, because you could not get over your initial mistake.
2. You could accept the fact that you were not a big-time risk taker.  You wanted to see evidence that there would not be a great depression.  At some point you decided to climb aboard.
3. You are still trying to decide.

Those taking Path 2 did great on a total return basis, making 32% plus dividends, but it required buying at a point of near-maximum risk.  It iss OK to be cautious, especially if you are preserving wealth.  The Path 3 investor has an opportunity that equals that of 2009 on a risk-adjusted basis.

Let us look at the data.

Getting a Second Chance

Usually we do not get a "do-over" in life.  Because of the pervasive negative sentiment about politics and the fear trade, the opportunity to buy traditional investments at good prices is still there.

T0 understand this, you must ignore absolute prices and forget about the fact that you did not  buy the market in 2009.  That is all history.  Where are we now?

	5/8/2009	12/8/2010
S&P 500	929.23	1228.00
Forward 4q eps	60.47	91.98
Forward P/E	15.37	13.35
Inverse of Forward P/E	6.5%	7.5%
L-T eps growth rate	7.0%	7.0%
10-year Treasury yld	3.2%	3.2%
Difference	3.3%	4.3%

Stock prices have rallied, but earnings estimates have done even better.  When you compare the market to the bond alternative, the yield differential is striking.  Regular readers know that I have produced unrefuted evidence that one-year forward earnings estimates are excellent.

Briefly put, if you have waited for a favorable risk/return to buy stocks, the time has come.

 

Investment Conclusion

Buying stocks today has more upside than at the bottom in the Spring of 2009.  Since many of the major issues are off of the table, there is even less risk.  Since many issues remain, stocks are still cheap.

The table shows the S&P 500 averages.  Successful investment advisors who have beaten these averages over a long time period may do even better.

There is an extra kicker.  The political dynamic has changed for the better.  As I noted in my weekly review, the tax and unemployment benefit compromises have dramatically improved the prospects for economic growth.  This will immediately help corporate earnings and eventually help the deficit projections.  Some market sectors will benefit more than others.

 

 

Comments

[Bob G.]

I can't let this go without another comment. Mike C is correct in that price volatility does not necessarily equal risk. You may have had more risk in the near term (Spring 2009), but over the long term it is meaningless.

When the general investing public is in panic mode, equities actually become less risky, rather than more so. The metrics I'm more concerned with are readings of the put/call ratio, ARMs index and other sentiment measures. Granted, leading into March 2009 these had been at panic levels for months and it seemed like the decline might never end, but it would and it did.

I'll admit I was scared and very close to getting my first margin call back then. But with an extremely large number of investors throwing in the towel I knew there would, at least, be a bounce of historic proportions.

To argue that since the economy appears to have stabilized the market has more upside potential is wrongheaded in my opinion.

Jeff, you've been very diplomatic in your counterpoints, but I still believe you are in error.

[oldprof]

Mike C -- I am sure that you understand that sometimes words are used in a plain English sense. As to risk, WB recently said that he could not understand why anyone would own bonds right now when they could own stocks. That seems like a pretty strong risk/reward statement.

One of the things that I have learned in five years of writing the blog is that no matter what I say, many will disagree.

I appreciate the fact that you still find the commentary helpful!

Thanks,

Jeff

[Mike C]

This translates into lower risk than Spring of '09.

Make sense?

Yes, but I guess I wouldn't associate that with "stock riskiness". I guess I think about stock risk largely as the value investment community does as the possibility of permanent impairment of capital, not really what overall general business and economic conditions are (rail traffic, ECRI, ISM, etc.).

I suspect like valuation this is something we'll just agree to disagree on although I would simply note that all the top value investors such as Buffett, Berkowitz, Klarman don't think about "stock riskiness" in the way you are describing. Buffett wouldn't say a stock is more or less risky because of what the ISM number is now versus 12 months ago.

[oldprof]

Ken -- Most importantly, I did not intend any personal slight or characterization of you. It is sometimes difficult to respond and to capture exactly the right tone, especially when you disagree.

I congratulate you on your astute trades and I very much appreciate your participation in the discussion.

My "looking backward" reference has to do with CAPE. I do not think it provides a timely buy signal, especially when you have the 2008 data dragging down the averages. That was not the method that enabled you to buy in 2009. For most folks, it means waiting to see another 1980-type situation with high interest rates causing low PE's. These folks will not find any generational opportunities.

As to risk in early 2009, I completely agree with your characterization, which was part of my preview for the year. Many other intelligent observers thought that the risk was very great. We will never know how close we came to a further economic and market collapse. We only know how it turned out.

I have a simple point: The forward P/E is more attractive now than it was then. It is a fact, and one that most people seem not to realize.

Thanks again for joining in.

Jeff

[oldprof]

Brandon - I'm using Thomson/Reuters 4 quarter forward earnings as of the date listed.

Jeff

[Brandon Rowley]

What are you using for the forward e from 2009, actual or expected at that time?

[oldprof]

Mike C -- I meant "less risk" in a general sense, because all of the objective indicators I analyze on a weekly basis have improved. My (almost) weekly series on weighing the week ahead focuses on these key variables. It has been gloomy when things were gloomy and my official posture, reported each week, has been bearish in the past. If you look now at the ECRI, initial jobless claims, earnings growth, earnings expectations, consumer sentiment, ISM numbers, rail traffic, government tax receipts --- all are better.

This translates into lower risk than Spring of '09.

Make sense?

Jeff

[Ken]

Perhaps it is the Mike C risk definition discrepancy. By my definition of risk, INTC was vastly less risky and offered greater potential returns at $13/share, when I bought it, than is true today.

[Ken]

1) We appear to agree these are worries. These are maybe/maybe not future abstractions. That means today is different from early 2009 in the following way: we are not in the midst of a panic. By that very fact, today is not as good of a time to invest as early 2009 was. By early 2009, if you looked at the data, it was clear we were not going to have a Depression. Yet people were still living in 10/2008, and it was a truly once-in-a-generation (hopefully) time to invest, which is why I did.

2) Yes, of course I see improvement in the economy over the past 18 months. I also see the rising of various shoes, which may not drop, but which may, leading to another true panic which would create a much better buying opportunity than today is. This militates in favor of a large cash position, even if everything does go swimmingly and such a cash position ultimately reduces returns.

As for CAPE, as you know, Schiller extensively modeled equity returns following various values. Is it flawed? Sure, but so is everything.

I finally object to a characterization that I don't look ahead. One must look at both the past and to the future. It is equally foolhardy to look at one to the exclusion of the other.

These days therefore I am a modest equity buyer, a maintainer of most prior positions, but with a growing cash position, and virtually no bonds, except for some 30-year and 10-year TIPs. I don't pretend to be an expert, but that's just one view.

[Mike C]

Even if stock gains in the next two years do not equal those from 2009 (and are you confident that they will not) there is clearly less risk.

I think that many stocks will have great gains, and the risk is lower than in 2009.

I'm assuming by risk you are talking about price volatility? Can you expand on what you mean by "clearly less risk"?

I've seen two definitions of risk that are generally used. One definition is increased price volatility is increased risk. That is the conventional, academic definition I was taught in my MBA finance classes. By that metric, early 2009 was indeed more risky.

The other definition of risk is the Warren Buffett/Benjamin Graham school of thought which says risk is a function of valuation and cheaper prices give you a larger margin of safety. In this school of thought, the larger the price decline (assuming no impairment of long-term value) the less risky the investment is, not more risky simply because it is more volatile. Buffett has some pretty pointed comments about this in relaying his purchase of Washington Post at the depths of the 73-74 bear market which arguably rivaled the sort of panic conditions in late 08/early 09.

[oldprof]

Bob G -- You are looking at the reward without considering risk. I did both. You are also not using any metrics. Even if stock gains in the next two years do not equal those from 2009 (and are you confident that they will not) there is clearly less risk.

I think that many stocks will have great gains, and the risk is lower than in 2009.

Meanwhile, I congratulate you on your astute investments! I hope you continue to do well, and I appreciate your comments.

Jeff

[Bob G.]

I have to disagree with the assessment that the upside is greater now than in the spring of 2009. This notion does not make a lot of sense to me.

The spring of 2009 was a generational opportunity to buy stocks at bargain basement prices. The news was absolutely horrible which is when you want to invest.

Just take a look at a few stocks. You could have bought Freeport McMoran for under $20 (I bought it at $22). It's now over $100. Caterpillar was in the $20's and is now over $80. Bank of America rose from $2 to over $18. There are thousands of more examples of stocks with gains greater than 100%. I probably own 30 stocks that gained greater than 200% over the past 1 1/2 years. I know I sound like I'm bragging, but my returns have been astronomical. I certainly don't expect to get these types of returns from this point forward.

[oldprof]

Ken -- You are expressing the concerns of many investors, but not pointing out things that I am "missing." Rest assured that I am always aware of the most bearish forecasts out there!

Let me suggest the following questions:

1) Do you think the list of worries you pose are unusual? Unique? How do they compare to Spring of 2009?

2) Do you see any improvement in the economy over the last 18 months?

I suggest that you are looking at things in exactly the wrong way -- the same way that individual investors do when they buy high and sell low. There are always problems. If there were none, we would be at Dow 20K already.

The challenge is to have objective indicators and some discipline.

As for CAPE -- Does anyone have an actual trading history of this "system"? I do not understand the fixation of people on backward looking methods, but I love it.

It means that those of use who look ahead have an advantage.

Thanks for saying out loud what many are thinking, and I wish you the very best in your investing.

Jeff

[Ken]

Jeff, I'm not a regular reader. But I think the point you're missing, in this post at least, is the validity of the "E" in P/E. Sure, earnings very much look stable for the next year, I agree. Now they do. But what if Spain requires assistance and the Germans decide they've had enough? What if a potential asset bubble in China collapses? What if China has to stop buying our treasuries in order to cool down its internal inflation and what if other buyers besides the Fed refuse to bite because of our high debt with no end to its rise in sight? What if interest rates go up enough to cause a second leg down in home prices in the U.S.? Alternatively, what if Europes's austerity measures drag the rest of the world down? I could come up with more, and I don't know whether any of that will happen, but I think there are extremely valid reasons to be cautious right now. (And I'm one of THOSE who WAS buying like a mad sailor from about mid-10/2008 through 2/2009, when I finally exhausted my available capital just before the bottom.) There are lots of shoes that might drop, lots of reasons to worry. Also, if you look at CAPE, stocks don't look terribly cheap all. And, I think it is wrong to look at stocks being cheaper than bonds and say that's a reason to buy stocks. If both are expensive, that's a reason to hold cash.

[oldprof]

Mike C -- The point is that the upside potential is better now that it was then.

I actually think that the eventual move will be much greater. As regular readers know, I am looking for Dow 20K. While I am working on the exact definition and time frame, it is a few years.

Many of the worries and technical predictions have already been proven false. New ones are invented each week.

Those looking at trailing earnings will have to wait for several years to see this, and they will miss the move.

But I think you already knew my viewpoint.

Thanks for the comment.

Jeff

[Mike C]

Buying stocks today has more upside than at the bottom in the Spring of 2009.

Want to be sure I am reading that right. When you say spring 2009, not sure if you are referring to the Mar lows or the table value on 5/8, but I'll use 5/8 to err on the conservative side. S&P 500 is up 32% from 5/8/09 to 12/8/10. A 32% increase or more from here (more upside) would imply a new all-time high of 1621+ so I assume you are looking for 1600-1700 on the S&P 500 in this bull cycle?