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Why the Stock Market is Cheap Now

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I do not believe that we are at the bottom of this economic cycle and that things will only be rosy from here. Our economy is suffering, and for good reason. Folly and greed reigned supreme for a while, and now the bill is due, and it includes a freezing of credit and wide spread panic.

However, we are seeing some of the best stock valuations in the last century. Once fear of illiquidity dissipates, the stock market will get back to normal levels.

Consider the following:

• At the depths of the Great Depression, 1 out of 12 companies were selling for less than their cash holdings. In mid October 2008, it was 1 out of 10.

• The 12 month P/E ratio of the S&P 500 companies is 10.8, below the 1974 average. And while it was lower in 1983 (7 P/E), short term interest rates back then were 20%, and they are 2% now.

• The Volatility index (VIX) last week was at an all time high of 80 (up from 15 just five months ago). Historical data clearly shows the VIX is an excellent harbinger to bottoms, as the market reaches nadir when volatility peaks.

• In addition, there is no shortage of liquid funds. On June 30, savings accounts were at 82% of the market capitalization of all US stocks, a 15 year high for that measure. There is gigantic liquidity on the sidelines, waiting to be deployed.

The US economy may not be "fundamentally strong", as Senator John McCain claims, but we do account for 25% of global Gross Domestic Product (GDP), and that is more than the next four countries (Japan, China, Germany and the U.K.) combined. We also have the most competitive economy on the planet. That is why the world's major stock markets are down more than ours and our dollar is rising. As bad as it may seem here, it is worse overseas.

It is also worth remembering that Interest rates are low, the vast majority of people are gainfully employed, and the federal government is aggressively spending $700 billion on the financial bailout, which is bound to have an impact.

In the stock market, prices are set by the most desperate seller. But ultimate values are set by the cash flows and assets of the underlying businesses, regardless of the emotions of the crowd. During this crisis, plenty of dreadful outcomes seem possible, but that does not mean they are likely to actually happen. In times of crisis, people fail to make that important distinction.

Prices today discount complete disaster. Chaos and forced selling overshadow reason. But this storm of trepidation is exactly where the opportunity lies.

Successful investing requires a long term perspective, patience and calm. The fear is always buying too soon, being too early. There is no way to tell when the panic will subside. But it would be silly to expect that it won't.

The world is not ending. This stock market should not scare you. You should take advantage of it, by buying solid, well financed businesses, ones that will still be dominant five years from now, and that are available at clearly attractive prices.

This is why we at Wellcap Partners are busy buying.

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