Digging Out

05/14/2009 05:12 am ET | Updated May 25, 2011

I believe the US economy will continue to experience distress, and may take a long time to recover. It will probably take years for the Dow to see 14,000 again. But the stock market anticipates future events and will begin to move higher well before either sentiment or the economy improve. For the market to go up from here, the news doesn't have to be good. It just has to be not quite as bad as what has already been discounted.

It is clearly much better to buy at discounted prices than to invest when the market has regained its peak levels. And US Stocks are cheap, any way you look at it:

• As a percentage of GDP: At 59% of GDP stocks are at historic lows. The long term average has been about 75%.

• Compared to Bonds: The S&P 500's dividend yield moved above the yield on 10-year Treasury notes for the first time since 1958. Remember, stocks act a lot like long term bonds. When the price declines the coupon (dividend yield) rises, and subsequent returns increase.

• Compared to Gold: The S&P 500 index is priced at about 90% of an ounce of gold. Over the past 40 years, the S&P average was 1.6 times the price of an ounce of gold, and peaked at more than five times the price of gold in 2000.

• Cash levels on the sidelines: Now at 84% of stock market value, up from 43% a year ago and much above the 66% average of the last 50 years. Compare stocks to cash, which is now earning close to zero and almost sure to lose purchasing power in the coming years.

• The "Q" ratio, or the price of the stock market relative to the replacement cost of assets. Today's Q ratio has not been lower since World War II, implying extreme undervaluation, since it is cheaper to buy new businesses in the open market than to create them from scratch.

• 12-year low: In February, the Dow hit a 12-year low. That happened only twice before, on April 8, 1932 and December 6, 1974. Both were an excellent time to buy stocks, even though the economy was still far from reaching bottom.

• In real terms: At the levels of early March, the Dow was at the same inflation adjusted levels as in 1966. The S&P 500 is now 40% below its level a decade ago, rendering moot all the technological innovation, economic development and population growth of the last decade.

It is also worth noting that historically, a small percentage of trading days equaled a large proportion of returns. Davis Advisors did a study and found that an investor who missed only the best 30 trading days over a 15 year period saw their return go down from 10.5% to 2.2%. And an investor that missed the best 60 days had their return go from 10.5% to negative! It is very difficult to time the market and very easy to miss the best 60 days in 15 years.

Every country in the world is addressing the financial and economic crisis. The bailouts, stimulus packages, liquidity facilities, central bank interventions and regulatory reforms will pay off. The banks will finally get to the bottom of their writedowns, recapitalize with clean balance sheets and then start generating profits. In order to create revenue from the hundreds of billions they have been infused with, they will have to start lending. Investors will tire of zero-return government bonds and will seek higher yields.

While there is no ladder that reaches to Heaven, the ladder that reaches all the way down to Hell in a country like America is just as bogus.

Alan Schram is the Managing Partner of Wellcap Partners, a Los Angeles based investment firm. Email at