Hard Landing / Are stocks attractive yet?
And is it worth listening to the advice of the president of the United States?
Stock markets in America and Europe ended last week's trading at their lowest point in decades. Investors find themselves at a crossroads, facing two uncertain choices. One is to give up and abandon stocks altogether. The other is to decide this is the very time to leap in.
Last week was more than just another slip in asset prices. Some would call it a financial earthquake. For many, it proved that stocks just aren't worth the risk, unless you have an inside track of information or some other advantage.
Even the greatest fans of stock markets admit that they're volatile and risky. But they have faith that over the long term, stocks have to compensate investors for the risk they're taking and outperform other investment avenues, such as government bonds. If you hang in there, stocks will win, chant investment managers.
Last week proved this to be a lie. Even without the slide on Thursday and Friday, which merely drove home the point, it turned out that safe-as-houses government bonds beat the stock markets even over 30 years.
If you'd invested in 30-year U.S. government bonds 30 years ago, you'd have made 1,479% by the end of last week, calculates Ryan Labs Total Return Indices, which track bonds by continually adding the most recently sold security and removing the old one.
If you put the same money into a diversified portfolio of stocks, based on the MSCU index of developed countries, you'd have made 1,265%.
In other words, seen over 30 years, stocks didn't reward investors for the risk they'd taken. So why go there at all?
You can make money on the stock market. But to do that, you have to catch the indices when they're low and sell when they're high. The question is, of course: Are stocks at that low level yet?
The usual way to answer that question is by looking to profit multiples. You get that by dividing a company's market value by its annual profit.
Actually, there are many ways to calculate profit multiple - take net profit, or operating income, or net profit and deduct one-time elements, of average the data to find long-term trends. Today, whichever method you pick, you'll find that profit multiples are low, even relative to other financial crises.
Look at the chart, calculated by American economist Robert Shiller, one of the people behind the famous S&P/Case-Shiller Home Price index. He looks at and tracks stats over the long term. One thing he's looked at, is profit multiples of America's giant companies since 1880.
The chart clearly shows the Great Depression that began in 1929, the tech bubble and the awakening, and the bloated share prices in 2007.
From October, the world markets have lost $36 trillion in value and profit multiples have been in free-fall.
But are stocks attractive yet?
That depends who you ask. Just last week, during a meeting with British prime minister Gordon Brown, U.S. President Barack Obama made a surprising step into investment counseling with a comment that stocks are becoming a "a potentially good deal" for those willing to think long term.
Experts on investments are less certain. According to Shiller's data, the average profit multiple in the American stock market is 12, which is low from the long-term perspective. But that doesn't mean that profit multiples have bottomed out. Stock markets could still fall, by a lot.
First of all, profit multiples have been a lot lower, for instance in 1982, when they fell to 7.
In 1927 and 1932, these multiples fell below 6. Stocks still have to lose 40% to 50% to reach single-digit profit multiples.
Second of all, a profit multiple is 12 is based on the companies' 2008 profits, and all indicators are that they're going to do a lot worse this year. And that means their profit multiples will be climbing anew without any change in their share prices.
Maybe Obama is right. Maybe in a few years we'll look back and realize that share prices had been at bargain-basement levels. But it's a lot more likely that share prices will look much more like bargains in six months.