Why the Stock Market is Cheap Now

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.

Comments

[1201SLD]

"Why the Stock Market is Cheap Now"

Uh, well, maybe.

Let's assume our analysis of company strategy, target market, management, staffing, sales and revenue volume, cost of goods and production, quality of reporting, tax liability, problem recognition, remedial management and a hundred other things are all correct. Then let's assume our analysis of market and economic conditions, regulation and taxation, company, industry, country, and cross-border risks, and relevant rates for capital and returns are all spot on. Evaluate competition and mix well. Season with sound assessment of investment depth and market psychology. Fold in factor for reasonable contingencies; and another factor for unknowable contingencies. Discount for mistakes, lies, greed, and stupidity. Project this concoction and every variable within it a few years into the future. Conclude assemblage and half-bake. Place available capital accordingly. Think through decision-making process. Get a good night's sleep. Repeat entire process daily to decide when to add cash or hope to reclaim capital.

And you want me to put my money where?

[worldtraveller]

Always amazes me that VIX assumption. VIX is based more on average daily price moves than expectation of future price. Market has been moving hundreds of points each day... so high VIX. That is all.

[democritus]

I think this comment is timely.

Perhaps more than many people I saw this crisis coming. But now I am getting the feeling that--guess what?--real estate is still worth something and going to be worth something. The economy will still exist tomorrow. There are six billion people out there who have to spend money to survive.

At some point the exuberance becomes irrational, and the same is true for the pessimism.

[dadw5boys]

MANY COMPANYS ARE ONLY SHELLS .

THE INSIDERS CASHED OUT ALL THE EQUITY IN THE LAST 16 MONTHS.

BECAREFUL WHAT YOU INVEST IN.

[JBS]

"This is why we at Wellcap Partners are busy buying."

And this is why WE out here, who work for a living, whose taxes paid for your bailout, don't have any money to buy with.

[drkazmd65]

Seconding what KTM has listed below,... risk always should be part of the equation,...

After all,... there is a REASON that all that capital is sitting on the sidelines in 'savings' accounts. And there is a reason that the market has tanked to the point where 1 out of 1o companies were selling for less than their cash holdings,...

And it is all about uncertainty, and about risk. Yes, it is probably still wise to play with stocks of one is thinking 20 years down the line,...

Problem is,... today is risky.

[KillTheMessenger]

Alan, I have searched for the word "risk" on this page and it is not here. What does that tell us about the quality of your advice?

:-)

[Rule Of Law]

Well, it's only a risk for us, isn't it--hardly worth mentioning at all.

[KillTheMessenger]

True, our risk is his income. Just what was I thinking?

:-)