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Sunday, February 24, 2013

Whither Stock Prices? ... That is the Question: Time to Buy, Sell or Hold? ... And the Correct Answer is as Always, "IT DEPENDS"

The Dow hit 14,000 Friday and is approaching its all time high. Similarly, the S&P 500 has surpassed 1,500, approaching an all time high, too.

So is it time to buy, sell or hold? Well, like all accurate answers to interesting questions, the only correct response is, "It depends."

And depends on what, you ask? Well, it depends on whether you're a long term investor, an oldster finishing up his working career or a younger person working hard to accumulate an apprpriate nest egg for the day when you reach oldster status and retirement.

In any event, here's my long term guesstimate (or SWAG, which stands for Sophisticated Wild A _ _ Guess) as to where prices are headed over the next ten to fifteen years --- 30,000 on the Dow and 3,000 on the S&P 500 Equity Index. I also expect that dividends which now yield ~2.5% will at least double in dollar amounts as well.

That said, with all the bumps and potholes along the way, we'll probably see numbers like 8,000 on the Dow and 800 for the S&P along the way to these higher levels.

But trendwise, it looks good for a double from these levels over the next ten to fifteen years to me.

Now let me explain why I believe this, even though my crystal ball comes with no guarantees. In fact, for those familiar with stock prices over time and the rule of 72, it probably isn't any better than anybody else's crystal ball.

I'm simply basing my views on history, probabilities, logic, earnings, current valuations, inflationary estimates and the way markets tend to function over time. And by the way, because I believe in the free market system and limited government approach that Americans have long embraced and will again sometime soon as well.

Reasons to Avoid Buying Stocks, and Why You Should Ignore Them makes the case very well for the expected "double" from what appear to be these current lofty levels:

"THERE are always reasons not to buy stocks. Investors may think the Dow Jones industrial average is too high, as was the case in 1954 when the index topped 360. In 1941, there was Pearl Harbor. In 1962, the Cuban missile crisis. In 1997, the Asian financial crisis.

The list, adding up to 78 for each of the years from 1934 to 2012, was compiled by Bel Air Investment Advisors.
 
But the punch line to this list was that stocks went up by an annual compounded rate of 10.59 percent over those 78 years, with occasional plateaus, and that $1 million invested in 1934 was worth $2.4 billion in 2012.
 
As for the last three years, the list singled out the European financial crisis in 2010, the downgrade of United States’ credit rating in 2011 and the political polarization of 2012. Investors were, in fact, generally reluctant to buy stocks. Yet in each of those years, stocks either rose in value or, at worst, were flat.
 
The reason for such hesitancy is obvious. Investors are still scarred from the 2008 crash and they perceive stocks as risky, a feeling reinforced by a good bit of volatility in the markets in recent years.
 
Yet as stocks rallied earlier this year, money from individual investors began to trickle back into equity funds. This could be good for an intrepid few.
 
“The stock market is the same place it was in 2000 with double the earnings,” said Todd M. Morgan, senior managing director at Bel Air Investment Advisors. “Stocks are set to outperform bonds over the next three to five years.”
 
This may very well be true, but most people still think fearfully about stocks. What would it take to get more people to buy stocks? And by this, I don’t mean going all in as investors did in the late 1990s, but creating some semblance of a balanced portfolio.
 
Mr. Morgan and other advisers said that investors are being misled by talk about near-record levels for the Dow Jones and Standard & Poor’s 500-stock index today. When adjusted for inflation, the levels approached earlier this year are not true highs. A new high for the Dow, for example, would be around 15,600.
 
What is more telling are the earnings and dividends of companies. Niall J. Gannon, executive director of wealth management at the Gannon Group at Morgan Stanley, calculated that the dividends on S.& P. 500 stocks were $15.97 in 2000 and $31.25 in 2012. Earnings per share were $56 in 2000 and $101 in 2012. In other words, two major measures of a stock’s attractiveness have doubled in the last 12 years, but the index has not kept pace.
 
“A big mirage is going on in investors’ minds,” Mr. Gannon said. “They think stocks are expensive because they’ve used index levels as the measure.” . . .
 
There is an alternative view, of course, that says the unwillingness of people to invest in stocks now is completely normal and that what happened in the 1990s with stocks and in the 2000s with real estate were anomalies, at least for average investors. 

 “The alternative to investing or saving is spending today and that is always infinitely more pleasurable,” said Don Phillips, president of investment research at Morningstar. “Throughout the ’80s and ’90s, you had this amazing bull market and it gave you this immediate gratification that usually only spending gives you. Now we’ve been through a more realistic period, and people realize that is not always the case. The reward is deferred, and there may be severe losses.”
 
Mr. Phillips noted that if people were able to pick a winning stock 55 or 60 percent of the time, they would be remarkably successful. But in spending money on something they want today, their success rate is automatically 100 percent. . . . 
 
Greg B. Davies, head of behavioral finance at Barclays Wealth and Investment Management, said people could persuade themselves to increase their allocation to equities by joining investment clubs where the group, in theory, would be better at making a decision that was painful. People could also slowly buy the stocks they want, a process called dollar-cost averaging.
 
“The classical economics position on all of this is that it is irrational and you should ignore it,” Mr. Davies said. “That’s not very helpful advice. We do have an emotional response.”
 
He said he would instead encourage average investors to forget about maximizing their risk-adjusted returns and aim for their “best anxiety-adjusted returns.”
 
For those with more fortitude, the simplest solution is to take the long view — as in 10 or 20 years, which is a lot of delayed gratification.
 
“Whenever you’re having a discussion like this, time horizon is a key consideration,” said Bill Stromberg, head of global equities at T. Rowe Price. “Most investors have been conditioned to think the next six to 12 months out. It’s too hard for anyone to predict what’s going to happen then.” . . . 
 
It is entirely possible that stocks will lose value across the board this year or the stocks you pick will fall significantly. But that is why every adviser stresses diversification and a long view. What matters is how a portfolio’s returns look in a decade or two, not tomorrow."
 
Summing Up 
 
Stock prices are not "irrationally exuberant" today. They aren't as cheap as they were a few years ago, but when earnings and dividends are taken into account, they are about 50% lower than they were in 2000.
 
The U.S. economy will gather strength during the next decade and enough government aristocrats will come to their senses about the need for the private sector to take the lead, if only because government leading the way never works. Accordingly, out of necessity we'll change direction and allow the free market and free risk taking individuals and companies to demonstrate once again the wonders of our free enterprise system.

And if the pols don't "get it" on their own soon enough, We the People will insist on the change in direction at some point soon, because losing isn't fun, and our economy and citizens have been losing the economic game for no good reason and for far too long. We can't eat empty promises.
 
Freedom and entrepreneurialism are essential parts of our nation's moral DNA, and free markets have provided us with the highest standard of living on the face of the earth and the history of the world. We'll never give those freedoms up.
 
And that's why reaching 30,000 on the Dow and 3,000 on the S&P 500 within the next ten to fifteen years along with a doubling of cash dividends from their current amounts look like easily achievable targets to me.

It's merely a "lapsed time free market rule of 72 thing at work," if nothing else.

And best of all, getting that kind of exceptional performance only requires that we "amateur" investors not panic and stay the course while investing in a low cost passive S&P 500 Equity Index fund.
 
That's my take.
 
Thanks. Bob.

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