I don’t mind telling you that these are scary and depressing times for investors. One wave of bad news no sooner breaks over us than another one–even bigger–appears.
The American banking and auto industries are circling the drain, and the Dow, which was within spitting distance of 14,000 just a year ago is now, having cracked the 8,000 level, trying to decide whether to rest there for a while or just plunge further. If you had bought a Dow index fund in July 1997, you might be exactly even now.
Billions of dollars in stock value have been lost and nations are expending trillions in debt to try to shore up credit markets and limit the depth of the recession that’s now officially confirmed in the U.S., Europe, Japan and lots of other countries.
All in all, it’s enough to make you turn off your TV, limit your newspaper reading to the sports and funnies and abandon your computer for your game console. At least in World of Warcraft, you know the rules.
Believe me, this deluge of bad news hits financial writers, too. Cabot Market Letter’s Model Portfolio and Cabot China & Emerging Markets Report’s portfolio, between them, have zero stocks. They’re both fully in cash, which means that the declines in stock markets in the U.S. and the emerging markets just makes their relative performance look better. But the market is still depressing.
It’s rewarding to have warned people away from a dangerous bear market, but it’s no substitute for the thrill of the hunt, finding great growth stocks, telling people about them and then watching them rise. We know that money saved is money that can be put back to work when markets turn up, and subscribers have told us that they appreciate the money we’ve saved them. But we get impatient and nervous like everyone else.
One idea that we’re actually happy about is the notion that markets may (note the emphasis on may) be nearer to a new bull phase than the toxic headlines would lead you to believe.
We have three big pieces of evidence for this contention.
1.) Extremes lead to reversals. The concept of reversion to the mean applies to any situation in which values move toward the limits of a central tendency. In this case, the price-to-earnings (P/E) ratio of the broad-market S&P 500 Index averaged 17 from 1955 through 2005. The spike to over 45 during the height of the Tech Bubble signaled a huge divergence from that mean, and when the Bubble burst, the P/E headed right back to the average.
Today, the P/E ratio of the S&P 500 Index (based on trailing earnings) is between 10 and 11.
2.) History tells us that markets lead economies out of recessions, and not the other way around. Stock investors make money by looking at where markets are headed, not where they’ve been. The collective wisdom of the entire population of equity investors has always been a better predictor of where the global economy is headed than any leading indicators or economists.
3.) Markets always bottom out and start their recovery while headlines are at their gloomiest. Again, that’s because the headlines are telling you what happened yesterday, while the markets are like camels that can sniff water 20 miles away.
Predictions are not part of the Cabot growth investing discipline. I don’t even try to make them. Strict avoidance of predictions is built into the market timing indicators that we use to advise our subscribers when to be in the market and when to get out. It’s why we avoided this disaster!
So I can’t say that I think things are about to get better. But I can say that it’s when things are at their worst that improvement begins.
Taken together, these reasons point to the possibility that the markets may be putting in a bottom. Then again, they may not.
The important thing is that Cabot’s growth disciplines will recognize the new uptrend soon after it arrives and will begin finding the leaders and telling our subscribers. Then it’s just a matter of following the rules: Let winners run. Cut losses short. Stay on the right side of the market.
Hard times may be good news