TMFDeej (99.47)

One word describes why I'm not buying into this rally...

April 03, 2009 – Comments (13)

One word describes why I'm not buying into this rally, both literally and figuratively...EARNINGS. 

Stocks can fly all over the place in the short run, but real, sustainable rallies are built upon solid earnings and the potential for growth.  I came across an interview in Kiplinger's with David Tice today that sums up this line of thinking beautifully. 

Tice, founder of the Prudent Beat mutual fund, not surprisingly is, well bearish.  Despite the fact that he is talking his book so to speak as the manager of a short fund that returned 36% in 2008, his argument on why the current rally in stocks will not stick makes sense.  Here's a portion of the interview that I find particularly relevant:

"...And the key fundamentals are?

Earnings for S&P 500 stocks were far down in 2008, and 2009 earnings aren't going to be any better.  S&P earnings will probably be below $40 per share this year [versus $65 in 2008 and $83 in 2007].  So the market's price-earnings ratio, based on 2009 estimates is 20.  That's still high, so how can you think that the market is near a bottom?

What will it take for the market to bottom?

It depends upon whether the stimulus package gets teeth, it depends on the dollar, it depends on what the Chinese decide to do.  There are a lot of moving parts here.

What do you mean by the stimulus getting teeth?

A strong stimulus package could mean the economy picks up a little bit in the short term, but I don't think it will work longer term.  The Italian finance minister recently said, "When the problem is too much debt, you can't fix the problem by assuming more debt."  The problem is we have an output gap.  We have too much capacity for existing consumer demand, and, therefore, manufacturing, retailing, and other sectors will have to downsize."

I completely agree with Tice.  He is a little more bearish on the current state of the economy and where the markets are headed than I am, but not much.  Regardless of whether the U.S. government is able to reflate this bubble once again, as it did after the Tech bubble popped, or not there is just too much debt out there on the consumer side and the government side for us to resume the same level of growth that we have experienced over the past decade.

When consumer spending accounts for 70% of an economy, we should have never let it get that far, and consumers are leveraged up to their eyeballs, eventually growth is going to stall.  The government needs to focus on building a real economy, where we actually build things that we can sell to other countries and add value rather than just consume, consume, consume, serve each other $10 double-caramel-cheesecake-whipped-soy-white-chocolate-grande-mochachinos while we consume, and give each other advice on how to move money around to make it appear to grow even though nothing really is.

The U.S. economy didn't grow nearly as rapidly as it appeared to over the past decade.  The only thing that grew was the leverage in the system.  Much of the growth that everyone thought was real was just smoke and mirrors.  Now it's time to pay, and at exactly the wrong time, when the largest generation in the history of the world is passing its peak spending years.  Not only have Baby Boomers past their peak spending years, but they have seen a tremendous percentage of their wealth, which they desperately need for retirement, evaporate.  The rebuilding of their balance sheets will only serve to accelerate their natural slowdown in spending.

I'm not an uber-bear who thinks that we're all doomed.  I'm just a realist who doesn't see where growth is going to come from over the next several years.  Growth is what Mr. Market awards high multiples for.  What sort of earnings multiple would you give a company that you knew isn't going to grow much, if at all, over the next several years?  Not much of one I assume.  Certainly not the 20 times forward earnings that the S&P is currently sitting at. 

I plan to continue to play it relatively safe with my investments.  Could I miss out on the beginning of the next amazing bear market?  Of course, we're certainly a lot closer to the bottom than we were 50% or so ago.  It is entirely possible that I'm wrong and that I will miss out on amazing capital gains over the next several years, but again I just don't see where earnings and growth are going to come from.  I have a family to take care of so I'll just stick to my corporate bonds, with solid yields of anywhere from 7% to double digits and leave the quest for growth to someone else.

Deej