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> -----Original Message-----
> From: John Cappello [mailto:jvc689@xxxxxxx]
> Sent: Friday, September 06, 2002 10:17 AM
> To: Gary Funck; Realtraders@xxxxxxxxxxxx Com
> Subject: P/E inflation and the tenuous relationship between E and P
>
>
>
> Several months ago I ran a similar post pointing out the S&P 500
> could move extremely lower based upon PE ratios being out of line and
> growth rate not compensating for the same.
>
> This study done by Gary is much more erudite...but there are missing
> factors.
>
> 1. There is nothing to say that the powers that be who control the
> composition of S&P 500 stocks will not readjust the composition and
> delete non-performers and replace them with performers.
Well, the study that I ran looked at S&P earnings and prices for the 14 year
period from 1988 to 2002. Certainly, during that period we saw many
additions and deletions to the index. Thus, the average 6.2% increase in
earnings was inclusive of the S&P analyst's best efforts to adjust the
index. That 6% figure is consistent with longer term S&P studies as well.
>
> 2. The Pshchology of the market and the Mutual Funds will not
> liquidate unless absolute necessity forces them to do so. While spot
> monthly liquidations excess vs new money has shown this to occur, it
> would need to be on a prolonged basis.
A certain level of buying demand is required to keep prices from falling,
and more buying is reuired to move them higher. The buying overcomes the
base level demand as people liquidate stocks to fund their retirement, put
their kids through school, buy a vacation home, or to make ends meet after
being laid off.
The risk for the market is that investors (including retirement funds, and
other institutions) change their investing preferences to competing vehicles
such as bonds, real estate, and commodities. Some of that has already been
happening. Clearly, only the intervention that has artificially lowered
rates has kept bonds from stealing more of the investor's funds.
>
> 3. Retirement accounts have suffered the worse over the past 3 years
> similar to the 70s. They too are in no position to liquidate.
Won't they liquidate as retirees need their funds?
The bigger picture view is that for the market to move up, there must be
steady buying well in excess of withdrawls. The market can go down even if
retirement funds choose not to sell stocks and reallocate to something else
like bonds for example.
By the way, there have been reports that insurance companies have been under
some pressure to liquidate as the market goes lower, because they have to
keep a certain amount of cash reserves on hand to support redemptions and to
ensure solvency.
> Most
> journals including the AARP point out that the majority are cutting
> back consumption or taking on PT jobs.
This doesn't sound like a formula for increased stock buying. <g>
I guess your point is they prefer to work at McDonald's instead of selling
their stocks at a loss?
> I checked The American Funds
> during the 70s and even then one could withdraw 5% per year from
> principle during the worst years and still have almost doubled their
> money after the completion of a 10 year period.
I checked Shiller's S&P 500 price and dividend data,
http://www.econ.yale.edu/~shiller/data/ie_data.xls
According to this data, for the decade 1970-79 with dividends re-invested
monthly, the total return (stock price appreciation plus additional
dividend-reinvested shares) was 4.78%. Of that total return 3.08% was due to
dividends alone, and 1.08% was due to S&P price appreciation. Unfortunately,
inflation ran at 7.36% which totally overwhelmed the modest stock gains.
Oddly enough, three month certificate of deposits would've paid 7.24% over
that same period, reinvesting monthly.
>
> My observation is that investors who never followed Graham/Dodd
> analysis will just hang in until market prices recover.
Or, until they need the money, and have to liquidate at a loss?
I know several people with sizeable retirement accounts who have been
liquidating their stock funds, because they've seen their substatntial gains
whittled away. Prices were getting low enough that they felt their financial
future (and retirement) was threatened. Selling at the bottom? We'll see.
> What I see is
> the short term commodity trading mentality at odds with the long term
> investor mentality.
I don't think these long-term valuation and return studies have much to do
with commodity trading.
>
> My commodity trading is unlike my investment philosophy...as I think
> it should be.
>
> I am not prognosticating but I still believe that the American Stock
> Market will continue to increase an average annual minimum of 6% per
> year over time. This would lead to a doubling of the Dow every 12
> years. There may be flat years. There may be losing years. But there
> will also be outstanding years.
>
> I would not let pure logic predict the market. If that were the case
> there would be a lot more millionaires via the market.
>
> I posted a chart showing that over the last 3 months of the year for
> the last 10 years that the market has risen.
That's a market timing strategy that has little to with the type of
long-term investing that most individuals and institutions practice.
> Dow 10,000 to 12,000 is
> just as possible as Dow 6000 or lower by year end. If it is 6000, do
> you buy or sell at a bottom? If it is 10,000 to 12,000, do you keep a
> pat hand or liquidate and go to cash, bonds and/or long term CDs?
>
> Just rhetorical questions.
Those are actually good questions. They're difficult to answer. The point of
the various valuation studies in my mind simply underline the fact that
there is a lot of investment risk in the market at the moment, and investors
are not being compensated for the risk (via high dividends, for example).
To answer your questions above, I'd average into stocks with DJIA below
6,000 and average out with DJIA above 9,500. I'd look to overweight bonds (2
to 3 year treasuries) until the economic picture is clearer.
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