This blog post originally appeared on RealMoney Silver on April 6 at 8:28 a.m. EDT.The Little Engine That Could (also known as The Pony Engine) was a book written by Mary Jacobs in the early 1900s. It is a moralistic children's story about a stranded train who is unable to find an engine willing to take it over difficult terrain -- that is, until a little blue engine comes to its aid. And while repeating the mantra "I think I can ... I think I can," that little blue engine overcomes the seemingly impossible task of bringing the train to its destination. The metaphor of The Little Engine That Could applies to life and to the current state of the stock market. Early in the week of March 2, I appeared on CNBC's "The Kudlow Report," where I asserted that the U.S. stock market was within three days of bottoming for the year, and quite possibly for a generation. On Friday, March 6, following two days of further market weakness, I reaffirmed my prediction that the bottom was in. A week later, on March 9, I reemphasized my generational low bottom call to a skeptical crew on CNBC's "Fast Money." On that show, I cited multiple valuation models I use to assess the current value of U.S. stocks, all of which made it clear to me that equities have incorporated a lot of bad news and were undervalued both absolutely and relative to fixed income:
- The risk premium, the market's earnings yield less the risk-free rate of return, is substantially above the long-term average reading.
- Using reasonably conservative assumptions (most importantly, a near 50% peak-to-trough earnings decline, which is over 3 times the drop in an average recession), the market has discounted 2009 S&P 500 earnings of about $47.
- Valuations are low vis-à-vis a decelerating (and near-zero) rate of inflation. Indeed, the current market multiple is consistent with a 6% rate of inflation.
- Stock prices as a percentage of replacement book value stand at 1 times, well below the 1.4 times long-term average.
- The market capitalization of U.S. stocks vs. stated GDP has dropped dramatically, to about 80%, now at the long-term average. Warren Buffett was recently interviewed in Fortune Magazine and observed that this ratio was evidence that stocks have become attractive.
- The 10-year rolling annualized return of the S&P is at its lowest level in nearly 75 years, having recently broken below the levels achieved in the late 1930s and mid 1970s.
- A record percentage of companies have dividend yields that are greater than the yield on the 10-year U.S. note. At 46% of the companies, that is over 4 times higher than in 2002 and compares against only 5% on average over the past 30 years.