Will We Hold It Wednesday – Dow 27,000, S&P 3,000 Edition

Doesn’t this seem to happen a lot? 

We get right up to these critical levels on happy talk over Trade and the Fed and Earnings but then, just as the Media is telling us how great things are and what a fool you are for not chasing the market – it all falls apart – again.  To a large extent, it’s because the indexes (and the individual components that make them up) are already priced for a perfect outcome. 

When you pay 30 times earnings for a stock, you are getting an effective return of 3.3% and there is, of course, the risk that something bad might happen over the time you hold the stock, causing it to go down, not up.

A 30-year note yeilds 2.2%  and has, theoretically no risk – though the real risk is you are locked into the low-rate note while inflation rises faster than your note or that newer notes start giving a better return than your note – causing the present value of your note to go lower.   That would not effect your 2.2% reuturns but it would make it almost impossible to sell your note to someone else without steeply discounting it. 

Still, the “risk-free” rate of return is 2.2% while a 30x stock is giving you 3.3% but should just 1 out of 3 of your stocks fail to go up this year, your rate of return drops to 2.2% anyway.  That means you have to be right 66% of the time with your 30x picks just to keep up with TBills.   We are able to do that using options since Being the House gives us an inherent advantage but people buying straight stocks at these prices barely stand a chance.

In the last Recession, ALL the stocks went down and the bonds went down too – there was no escaping the carnage.  THEN it was a no-brainer to buy up blue-chip stocks that were trading for less than 10 times what they earned in a year – giving you an effective 10% annual return – no matter what the PRICE of the stock was.  That happened in 1973 (Nixon Impeached), 1987 (S&L Crisis), 2000 (Dot Com Crash), and 2008 (Housing/Financial Melt-Down) and now it’s just about to be 2020 and we have a Unicorn Crash, Trump Impeachment, Trade War, Brexit and a Global Recession – WHY would you buy stocks for 30x earnings in this environment???

As you can see from the chart, the S&P 500 has been valued higher than it is now – twice.  It has, however, been valued lower than it is now – ALL THE OTHER TIMES.  Overvaluations can last for a couple of quarters or a couple of years but we’ve already put in a solid year at these levels so not likely we go another full year without reverting to the mean. 

Yes, we are doing a bit of bargain-hunting but I’m not too excited about it – there are simply too many major macro events that could go wrong and force a drastic re-pricing of the market so please – be careful out there!

Provided courtesy of Phil’s Stock World.