Stocks Aren’t Cheap

March 9, 2009

The S&P 500 is trading at 30 times estimated 2009 earnings, not the low P/E Wall Street claims, that was light on stocks in 2008 and still is now.

The S&P 500 is trading at 30 times estimated 2009 earnings, not the low P/E Wall Street claims, that was light on stocks in 2008 and still is now.

But expensive stocks are just one symptom of a “global contextual transformation” that’s creating enormous fear as well as new opportunities. You’ll need a very different kind of diversification now than what worked during the boom years.

Five big-picture trends:

• It’s not a typical recession, and the stimulus bill won’t bail us out.

The economic downturn won’t correct itself anytime soon. The government’s stimulus plan won’t drag the economy out of the doldrums. Instead, it will boost the national debt, raise the tax burden and spur inflation. The economy won’t recover for years.

• Unrealistically low Treasury rates.

Government interest rates are artificially low and likely to rise.

• Inflated P/E ratios.

The swollen profit margins of recent years were an extraordinary and temporary benefit from credit-driven consumer exuberance.

• Consumers are keeping their wallets shut.

The vaunted consumer is finally being driven into retreat by creditors and won’t be restored to full shopping strength for a long time.

• More shoes to drop: underfunded public and private pension plans, state and local government budget shortfalls, overleveraged Europeans banks, credit-starved industrial companies, weakened insurers, outstanding derivatives, and the threat of renewed inflation.

Despite the gloom, you can still make money with investments.

• Go light on stocks, and be very selective. The only companies worth buying are in three categories: true innovators, market-share gainers capable of growth despite the economy, and ridiculously beaten-down stocks of good companies.

• Investment-grade bond yields are high, offering equity-like returns at a lower risk than stocks.

• Short positions - use both inverse funds that short broad markets and actively managed mutual funds that short individual stocks.

• Paired trades. Shorting the 30-year Treasury while going long on an investment-grade bond fund.

• Gold bullion as a hedge against paper-thin paper currencies. Gold still has the upside.

• Frequent rebalancing that takes makes volatility a friend not an enemy.

J. Michael Martin is a financial advisor at Financial Advantage (www.financialadvantageinc.com), which provides personal financial planning and investment-management services to retirees and aspiring retirees. He can be contacted at 410-715-9200 or mmartin@financialadvantageinc.com .