Thursday, November 20, 2008

BABIES & BATH WATER

HOLY COW!

I suppose if you were not prepared for the stock market's devastation and its wholesale destruction of wealth and security, what could you say about the ferociousness of this bear market?

Today alone:

S&P500 Index:
752.44 down 54.14 or 6.71 percent. Intraday low of 747.78. Lowest level since 1997.

Dow Jones Industrials Average: 7552.29 down 444.99 or 5.56%. Intraday low of 7507.60. Lowest level since 2002.

NASDAQ: 1316.12 down 70.30 or 5.07%. Intraday low of 1314.90. Lowest level since 2003.

In past months, when this observer suggested that the stock market could likely see the DJIA as low as 7,200 and the S&P500 Index at 700, the targets were predicated on several factors: 1) a bear market decline on the order of the 1973-75 decline - that was around 48 percent, and 2) a return to the price/earnings valuations (PE) in the pre-1995 era - a much lower average PE of around 14 or so.

So where are we now?

Since peaking at 1565, the S&P500 is down 52 percent. The DJIA is down 47 percent. NASDAQ is down 74 percent.


Honestly, you have to go back to the 1930s to see such breadth of declines. From March 1937 to March 1938, the stock market declined by more than 54 percent. Except for November 1929 through July 1932, when the market declined by a staggering 86 percent, no other bear market has been as powerful.

Let's look at some scenarios in attempting to value stocks going forward through this dramatic recession. Everything is based on a return to an historic "norm" PE of 14.

S&P500 earnings decline to 2005 levels: S&P500 value 979

S&P500 earnings decline to 2002 levels: S&P500 value 386

S&P500 earnings decline to 1997 levels: S&P500 value 556

Using a simplistic approach of averaging those corporate earnings levels, you can make a case for the S&P500 Index declining to 640. That would translate into a DJIA of 6400.

Recently, Standard & Poor's reduced their earnings forecast on the Index component companies for 2009 to about $49. Applying a PE of 14 to that number and you arrive at 686. By the way, the average S&P500 earnings for the aforementioned three periods was about $46.

The trouble is this, as if those numbers are not frightening enough. How predictable are corporate earnings in this environment? If the Big Three auto manufacturers cannot recover, the ramifications for the entire economy are monumental. Metals producers, electronics, glass, rubber, carpet, etc. will all be severely affected.

The other assumption here is that a PE of 14 will be seen as reasonable - not 12 or even 10. And if you lived through the 1970s and were an investor, those lower PEs were commonplace.

Bottom line: 7200 on the DJIA and 700 S&P500 may be too easy to reach. Investment managers and analysts that are suggesting we are at or very close to a stock market bottom should be history. They have no reasonable basis for such conclusions.

I have been pointing out the high dividend yields of many quality companies that are likely to survive the current devastation. Yet the yields continue to increase. The suggestion to me is that investors don't care. They just want to preserve their principal. As do I and as should you.

Wednesday, November 19, 2008

CASH REMAINS KING

Today, the stock market continued its trend to testing, and more than likely, taking out the prior October 2008 lows. In fact, both the DJIA and the S&P500 closed at their lowest since 2003.

The DJIA closed down more than 5 percent at 7997. The S&P500 closed down more than 6 percent at less than 807, smashing its October low of 830.

I haven't even commented on NASDAQ, which declined more than 6.5 percent today, blasting below its October lows.

While, as previously stated ad nauseum, we will likely see periodic rallies from such new lows, the stage seems set to reasonably expect to see the market continue to decline to 7200 DJIA and 700 S&P500.

Citigroup (C), the financial services and banking behemoth, set the tone for today, dropping more than 23 percent. Insurance companies, considered by average Americans to be pretty safe places, saw enormous losses, continuing trends not seen since the 1930s.

Pretty much, no place seems safe, feels safe if you are an investor. Oh, well gold was up 30-cents and ounce.

If you've been following any of the Capitol Hill testimony by the Big Three auto makers, I'm sure you are not reassured. After two days of testimony by the CEOs of GM, Ford and Chrysler, and the President of the UAW, no one in the Senate or the House is flashing any strong signals that they believe anything they are being told. It has been quite the spectacle. The CEOs of these manufacturing giants could not even tell their inquisitors how much cash they had on hand nor how much they really needed, let alone precisely when. Are you feeling warm and fuzzy yet?

If anything is being accomplished by these hearings, it is that management of these companies is as incompetent as anyone has been willing to suspect. Furthermore, they did their very best, including GM Chairman/CEO Wagoner in later interviews, how valuable they were to a recovery process. Really?

These are the folks that, on one hand, tout how many of their vehicles get more than 30mpg in the U.S. - on the highway. But guys, how about how many get more than 30mpg in urban driving? Hmmm?

They talk happily about how many new hybrids they "plan" to introduce in two years. But why didn't you produce them earlier? Like Toyota? Like Honda? Where has your management been? What have THEY been driving? SUVs?

The sad thing is that no one has grilled them about the higher fuel efficiency of dozens of models they manufacture and sell in Europe, and why they do not offer them here. No doubt, they have plenty of excuses.

Sadly, on one hand these guys just have to go. When I was an analyst in the '80s - back in Detroit of all places - it was all too evident then that U.S. auto management was in need of a major tuneup. But these companies cannot be allowed to fail. As has been accounted here before, there are simply too many jobs at risk, too many industries, too many small businesses and large businesses.

The auto execs seem to place the bulk of blame for their predicament on the recent economic downturn and tightening of credit. It's not like they've helped their own cause, requiring credit scores of well in excess of 700 - well in excess of 700 - to qualify for an auto loan. In light of this, to whom do they think they'll be selling cars? To Wall Street investment bankers? Oh gee. I forgot. They are all out of work. No job, well maybe no loan.

They've helped destroy their own market.

I fully expect that Congress will come to the rescue. Why not?! They've "tried" to rescue our major banks and the nation's largest insurance company, AIG, not to mention Fannie Mae and Freddie Mac.

Giant strings need to be attached to any auto bailout. This issue of more efficient European vehicles being available for manufacture here needs to be addressed. Labor costs MUST be brought down to levels competitive with domestic operations of foreign producers such as Honda, Toyota and Hyundai. Hybrid technology needs to be rolled out much much faster. GM needs to forget about charging - pun intended - $40,000 for an electric Chevy Volt.

Business as usual, led by the same tired management, must come to an end. Out-of-the-box thinking and management has to be injected into this industry. If not, they'll be back to the public trough sooner than you'll need to fuel up your Cadillac Escalade.