Is the Risk Worthy of the Reward?

Grab your party hat and whistle.  It’s time to celebrate.  Tomorrow’s the two year anniversary of the stock market boom that followed the 2008 financial panic.

What a boom it has been.  The S&P500’s up nearly 95 percent since the March 9, 2009 low when it closed at 676.  On that day the S&P500 was down 57 percent from its all-time high of 1,565 set in October, 2007.  Since then, it has logged its sharpest rise since 1955.

Those who bought the market on March 9, 2009, back when the sky was falling, have doubled their money.  Naturally, no idiots were buying stocks on March 9, 2009.  On that day, after watching the halving of their 401Ks, idiots were selling stocks.  Only the shrewd, astute, and fearless were buying.

Of course, when you buy and when you sell are the two most important trading decisions to make.  Obviously, you want to buy low and sell high.  Yet, most do the exact opposite…they buy high and sell low.

So now, after doubling in price, the idiots are jumping back in to the market at what may be the worst time possible.  Let’s explore…

Two Different Things

Mutual fund investors are considered “dumb money” investors by Wall Street.  For whatever reason, the little guy has an uncanny habit of selling when stocks have bottomed and buying when stocks have peaked.  DOW Jones Newswires reported on March 2 that “Long-term mutual funds had estimated inflows of $7.91 billion in the latest week.”  Of this, $2.5 billion of these inflows were into stock funds.

The stock market started off the year with a good push.  In January and February the S&P500 jumped 5.5 percent – off to the best start since 1998.  So far in March the stock market has stalled.

But who knows?  It could just be a rest stop before heading up and to the right.  Or, with a little imagination, it could be rolling over and commencing its descent.

Here at the Economic Prism we’ve been expecting the stock market to turnover and fall on its face practically since the rally began.  We don’t doubt that it could happen any day now…though we don’t have much to go on, other than what our gut tells us.

A review of recent headlines tells us the economy is improving.  If you can believe it, businesses added 220,000 jobs in February.  What’s more, unemployment has fallen all the way to 8.9 percent.  Still, one must remember that the economy and the stock market are two different things entirely.  An improving economy may not do much for a stock market that’s gotten ahead of itself.

Is the Risk Worthy of the Reward?

What we mean is, based on a look at the ratio of price to earnings investors are paying, stocks are expensive.  “Investors are paying 24 times inflation-adjusted earnings over the last decade,” reported AP last Friday.  “The historical average is 16.”

Plus, peering out from the vista, we see inflation and a government debt crisis looming just beyond the horizon.  Both are bound to cut into economic growth.  Nonetheless, a stock market boom can go on much longer than rationally possible – particularly when the Federal Reserve’s encouraging it.

“Legendary investor Jeremy Grantham, chief investment strategist of GMO, has a knack for timing,” noted AP.  “In a letter to investors released in early March 2009, Grantham argued it was impossible to declare a bottom in the stock market but said its steep drop was reason enough to jump back in.  He predicted that the combined efforts of the Fed and government spending would spur a stock rally ‘far in excess of anything justified by either long-term or short-term fundamentals.’”

Grantham, at the time, couldn’t have been more right.  So what’s he saying now?

“Grantham remains a critic of the Fed’s stimulus program but isn’t willing to say stocks have reached bubble territory.  At least not yet.  If the S&P500, now just above 1,300, climbs to 1,500 by October, then watch out.  At that point, he says, ‘it will be a market looking for an excuse to go.  On the first piece of really bad news it will make a determined effort to tank.’”

If Grantham’s right – again – the S&P500 could run up another 13 percent from here.  We don’t deny it’s possible.  But the question each investor must ask…

Is the risk worthy of the reward?

Only you can decide.

Sincerely,

MN Gordon
for Economic Prism

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