Despite a series of worrying news items last week, US stock markets managed to
deliver strong gains. Time and again, US investors seem to turn lemons into
lemonade by assuming each bad data point is an indication that the bottom is
in. Is such behavior indicative of a stock market revival or simply evidence of
a bear market rally?
For those who strive to think logically, the current market is a challenging
environment in which to make money. The present volatility has been
particularly difficult for those who gravitate towards the traditionally
conservative "buy and hold" approach.
The small investor is not alone in his confusion. Of some 90 university
endowments and similar foundations followed by Northern Trust, only 20% managed
a positive return in 2007. Even
those that did struggled hard to achieve an average return of 3.1%. On average,
public and corporate pension funds faired worse with negative returns of 4.3%
and 5.1% respectively. As a result, investors large and small are willing to
believe that any piece of news, good or bad, is the long awaited "all clear"
signal that will herald good times on Wall Street.
So with the US dollar appearing to recover (as recession is forecast in Europe
and elsewhere) and with foreign stock markets having experienced corrections,
is it time to look again at US equities? If the past decade is any indication,
the future looks bleak.
Although the recent US stock performance has indeed been bad, many would be
surprised to know that the weakness stretches back much further. In fact, the
major US averages for the first years of this bold, new 21st century are
anything but impressive.
On October 12, 2007, the Dow Jones Industrial Index, against which many
investment returns are measured, closed at a nominal high of 14,693. The media,
of course, reported it as a sign of good things to come.
On May 23, 2008, the Dow closed at 12,480 - down just over 15% from its record
close. Not too bad, on the surface, at least. However, if adjusted by the
official consumer price index inflation from January 2000 of approximately 4%
per year (which in reality is far below the rate of actual inflation
experienced by real people), the Dow in May of 2008 was worth only 9,856. If
this inflation-adjusted figure is compared to the Dow close of 11,723 on
January 14, 2000, US stocks were down more than 15% after eight years! And
that’s using the government inflation figures which are ridiculously
optimistic.
In sum, assume an investment of US$11,723 in the Dow average high of 11,723 on
January 14, 2000. The same money could then have bought approximately 460
barrels of oil, 40 ounces of gold and 9% of an average family home.
Some eight years later, the money in the Dow would have increased to $12,480,
for a nominal gain of $757, or 6.4%. But the $12,480 will now buy 355 fewer
barrels of oil (down 77%), 27 fewer ounces of gold (down 66%) and, despite a
massive fall in house prices of 15.8%, only some 6% of an average family home
(down 33%). In short, the investor of 2000 should feel robbed in "real" terms,
despite a "nominal" rise in the Dow of 6.4%.
On the other hand, many foreign stock markets and currencies have risen
substantially and have outpaced the costs of typical consumer necessities.
These are the kinds of returns that attract people to stocks in the first
place.
With growing evidence of international recession and increased credit woes, it
is likely that the earnings of many US corporations will fall, not rise.
Shrinking earnings will cause price-earnings ratios to rise, based on present
stock prices. This should make the current prices of many stocks look
"expensive", as they move violently sideways with a downward bias.
So beware the current rally in the dollar and US stocks. The fundamentals
remain miserable, and stock performance will ultimately reflect this reality.
John Browne is senior market strategist, Euro Pacific Capital.
(Euro Pacific Capital commentary and market news is available at
http://www.europac.net. It has a free on-line investment newsletter.)
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