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Doomsday scenarios attract attention. Bill Gross made a
call in September that generated a lot of attention, though the underlying message was flawed. He said, "The market needs to yield close to 3.5% before it approaches fair value, and that means Dow 5000."
As I explained in
my column on the subject, "dividend yields don't determine value," and any prudent buyer of a business knows that business value is determined by "earnings, cash flow and net assets... not dividends."
Bill Gross' message was worthy of attention because he may be the best bond manager around. Similarly, one of the best short-sellers around, David Tice, manager of the
Prudent Bear fund, has been preaching a doomsday sermon of his own. Among other things, Tice says that the Dow will reach 3000 before the bear-market decline is through.
The David Tice Rationale
Although Tice was a few years early in shorting the '90s bull market, time eventually rewarded his diligence. With a top-notch reputation for research (e.g., Tice publishes "Behind the Numbers," a $15,000 per year research product), his prediction of Dow 3000 merits consideration. Here are the main points of his market call as well as my comments:
Stocks need to fall further; post-bubble drops are typically 90%.
There aren't a lot of market bubbles with which to gauge the reasonableness of Tice's position. The market dropped 89% in the 1929-32 market. The backdrop for business was different then, though, with a depression and 25% unemployment, hardly comparable with the current economy. In the recent bear market, we came relatively close to the 90% mark anyway: The
, the source of much of the '90s excess, dropped about 80% from top (more than 5000) to bottom (1108).
Stocks trade at price-to-earnings ratios of 20; at the bottom of previous bear markets, they traded at 7 to 8 times earnings.
This assertion of Tice's isn't true: Only in the case of the 1973-74 bear market did equities trade at these levels. The economy isn't similar to 1974, when inflation was 11.1% and we were struggling with political uncertainty around Nixon and an oil embargo. The market didn't trade at 7 to 8 times earnings in 1932 because there were no earnings.
In other bear markets during the past 50 years, the low in the market did not correlate with single-digit P/Es, as you can see in this table:
As of last week, even after the recent rally, Value Line lists the current median P/E ratio as only 15.5. That doesn't seem excessive, given the current level of interest rates.
The economy is headed for a double-dip recession.
A lot of smart people have made this prediction, and that's reason enough, in my book at least, that the prediction should be discounted. We have a very steep yield curve. Without exception, there has never been a recession with a steep yield curve. In the only double-dip recession in the past several decades, 1980-82, the yield curve was inverted when the second recession started, as the
aggressively raised rates to stave off 13% inflation.
Market seers are a dime a dozen nowadays -- and that's about how much their forecasts are worth. More often than not, markets drop precipitously because of shocks to the system that are difficult, if not impossible, to predict.
There's also a psychological component that investors should consider: the unconscious bias that I think Tice and Gross probably succumb to, called the "self-serving bias." Tice, as manager of a short-selling fund, and Gross, manager of a bond fund, sell products that compete with being long equities. Naturally, they're more apt to see the problems of investing in stocks because of their self-serving bias.
The Turnaround Report
In the next issue of
The Turnaround Report
, I'll have a multi-page spreadsheet on an interesting turnaround candidate that one Wall Street analyst calls a "strong buy" with a "generous margin of safety."
Not so -- in fact, it's quite the opposite: This company has endured an
-type stock-buyback problem and has a huge pension problem and a decidedly negative balance sheet. (I'll include my adjustments, of course.) In addition, the CEO has made statements that don't mesh with disclosures to the
Securities and Exchange Commission
On this issue, I'm clearly biased and intentionally self-serving: I'd recommend a trial
Arne Alsin is the founder and principal of Alsin Capital Management, an Oregon-based investment advisor specializing in turnaround situations. At time of publication, neither Alsin nor ACM held a position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Alsin appreciates your feedback and invites you to send it to
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