Here's How You Figure Out Where the Stock Market Is Headed Next
Stock-Markets / Stock Markets 2010 Jun 06, 2010 - 07:03 AM GMTBy: DailyWealth
Dan Ferris wites: If you want to get an idea of where the overall stock market is likely headed in the next few years, just take a step back and think about Mr. Market's wild mood swings of the past few years...
After a three-year depression lifted in late 2002, Mr. Market became irrationally exuberant all over again. By late 2007, the S&P 500 hit a new all-time high. Stocks were king. Nobody thought about risk.
About a year later, risk was all anyone could think about. The market fell more than 50% from its late 2007 highs. That was the worst year since the Great Depression. Mr. Market continued to sink into an ever deeper funk as the market bottomed in March 2009.
From that point on, Mr. Market went back on the happy pills. He became more wildly manic than he's been in decades. At recent levels, the S&P 500 is up roughly 60% off its bottom.
Where are we now? The question is rarely this easy to answer.
The stock market is clearly overvalued by the three measures that count: price-to-earnings ratios, dividend yields, and the value of stocks relative to the whole economy. Let me show you...
The Wilshire 5000 Index covers all U.S. stocks from ExxonMobil down to those of less than $1 million in market cap. These stocks trade for around 23.4 times earnings. That's expensive. Flip that number upside down, and you get the "earnings yield" of the market. At 23.4 times earnings Mr. Market is offering you a 4.27% return on your money. That's not nearly enough. Inflation will destroy that return in the next few years.
The second important valuation measure of stocks is cash dividend yield. The yield on stocks right now is about 1.75%. At that rate, it'll take about 57 years to double your money. I'm 48 years old. I don't have 57 years to double my money. Dividend yields aren't in Extreme Value territory until they hit about 5% for the overall market.
Finally, U.S. stocks are currently valued at just about as much as the entire U.S. economy. The latest gross domestic product figure published by the Bureau of Economic Analysis is $14.6 trillion. The entire market capitalization of U.S. stocks is right around $14.5 trillion. Historically, the market has been overvalued above roughly 80% of GDP. Today, at close to 100%, the stock market is getting ridiculously overvalued. Mr. Market doesn't seem to understand there's a little more to the U.S. economy than 5,000 publicly traded companies.
I don't waste time predicting the short-term direction of the market. I only assess valuations and make a judgment based on how cheap or dear the market appears to be.
Stocks are pieces of businesses, and Mr. Market is asking too much for most businesses these days. Either the businesses rapidly grow in value, or the market corrects. It's not hard to believe a market correction is more likely than ubiquitous hypergrowth.
Moments like right now are when a compulsion to buy stocks will serve you worst. Don't buy any stock that isn't financially strong and demonstrably cheap.
For example, I love the idea of buying a cash-gushing, World Dominating franchise like Microsoft for around 10 times cash flow... or paying well under 10 times cash flow for ExxonMobil, the world's best-managed big oil company. I can't stand the idea of paying 15 or 20 times cash flow for your average retail, homebuilder, or tech stock.
Microsoft and ExxonMobil are both dirt cheap right now... and I'm willing to bet they'll be dominating their industries and treating shareholders right five, 10, probably 20 years from now. I can't say the same about the vast majority of the overpriced Wilshire 5000.
If you're like me – concerned about the overpriced market, concerned about another leg down in the housing market, and skeptical of Washington D.C.'s plan to borrow and spend our way out of debt – World Dominating companies are where you want your stock portfolio to be.
Good investing,
Dan Ferris
P.S. As I said, right now, you to want to be extremely selective about what kind of businesses you will buy... and extremely stingy on what price you'll pay to own them. I have a list of eight recommended World Dominators. Five are in buy range right now. These are the world's greatest businesses selling at absurdly cheap prices. To learn how to get immediate access to this list, click here.
The DailyWealth Investment Philosophy: In a nutshell, my investment philosophy is this: Buy things of extraordinary value at a time when nobody else wants them. Then sell when people are willing to pay any price. You see, at DailyWealth, we believe most investors take way too much risk. Our mission is to show you how to avoid risky investments, and how to avoid what the average investor is doing. I believe that you can make a lot of money – and do it safely – by simply doing the opposite of what is most popular.
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Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.
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