Summing Up My Concerns
"We still need the development of some events that are going to scare the hell out of people. That's what gives rise to that great environment where everybody wants to sell and nobody wants to buy. That's the raw material for our greatest returns."
-- Howard Marks, Chairman of Oaktree Capital Management (OAK)
Howard Marks' quote above rings true to me. There will likely be better times than now to be buying stocks at the margin.I am very concerned about the potential for a disappointing downturn in corporate profits, the likely deterioration in China's economy and a more rapid decline in the eurozone's economy than is generally expected in the months ahead. I will move back into a long position when conditions dictate, but, for now, with extreme levels of complacency, I am more bearish than I have been in a while. Time and time again, what I have learned throughout my investment career is that market participants prefer the comfort of crowds rather than the company of the remnants. Investors and traders, as demonstrated in recent years, seemingly prefer to buy strength and sell weakness than to address, anticipate and prepare for an inflection point or change in market direction. That helps to explain why the recent low-volume market rise has been greeted with growing optimism by relatively complacent investors. That said, the chart below on the S&P 500 (when combined with the low VIX reading previously discussed) suggests that a possible and classic triple-top in the market might be in formation. (If this turns out to be a triple top, a yearly market high might be close at hand).
Valuations Are Reasonable, but...On valuation, stocks now seem fairly priced relative to projected 2012 S&P profits -- the index is almost exactly at my fair market valuation of 1415. At slightly over 14x earnings, today's P/E ratio compares favorably to a five-decade average of about 15.2x and seems fairly priced against private market values and other metrics. Nevertheless, I view the elevated profit margins that support trailing earnings as vulnerable to downside surprises. And though stock prices are inexpensive to interest rates (the risk premium), we must recognize the artificiality of interest rates that form the basis of any interest-rate-dependent discounted share price value calculation. Finally, unlike the last 50 years, the domestic economy (and that of the world's economies) is laden with historically high debt loads and structural economic challenges.
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