While the stock market has moved up nicely in the last 3 months, it's hardly moved stocks above reasonable valuations. IBM sells at 12.77 times earnings. Intel goes for 11.67 times. Microsoft has a Price to Earnings ratio (P/E) of 11.74. Google sports one of 22.8, but even that isn't too noteworthy when many of these stocks at one time or another traded at 50 to 100 times their earnings. Of course, those were days when there was only up, and everyone was on ecstasy. Thankfully, every stock, and everyone, is back on earth.
Those relatively benign valuations come from the reality of a slow global economy. In the U.S. it's more like a smashed-into-a-brick-wall economy. No matter the degree of the economic slowdown, all investors are cautious, not willing to bid up stocks when they believe things will only get worse, that profits will only decrease.
Companies have reacted as any living organism does when threatened: they've gone into survival mode, cut costs to a minimum, laid off people, shut plants, minimized inventories. They don't know what will happen, but they feel what just hit. Many took losses as consumers stopped buying. They're scrambling to adjust to the new reality.
The thing for investors to remember is that economies go in cycles. While this one has been much deeper in its low levels, it will end. There will be a time when consumers open their shutters and drapes, let in the sun again, walk outside and start spending. When that will happen is anyone's guess, but it will most assuredly.
When it does, expect to see a stock market rally that will be breathtaking in its rise. Much like a rocket ship that takes months to prepare, fuel, then launch, the stock market will move higher at remarkable speed, maybe gaining as much as 1000 points in a day. And why would it do that?
Because the very companies that are now running on skeleton crews, gas vapors, and lots of hope, will see a tsunami of profits in the first few quarters of an economic turnaround. They will be slow to hire workers, push their existing staff to their limits, and see their bottom lines inflate like an emergency raft from a downed airplane. Profits will boom as companies scramble to keep up with orders.
A good example is the housing industry. Right now consumers aren't buying too many houses, either because of financing problems, no jobs, or just scared. The psychology is one of wait and see. The longer they wait, they assume, the better prices they'll see. That's certainly paid off the last 3 years. But when that thinking changes, and housing is seen as a good investment again, the scramble for a house will re-enact the land grabs of the early pioneers. And the largest beneficiary of that change will be the builders who have lots of land on which to build or decent inventories for sale. They will raise prices as fast as demand allows. Their profits will soar because they've got what people want. And their overhead will be minimal, having prepared for the worst.
Smart investors aren't looking at today's markets. They're looking ahead at the possibilities, thinking of different scenarios. If you haven't allowed the idea of a remarkable market rally into your calculations, you may miss a great opportunity. While the current stock market is somewhat stagnant, it offers one of the rarest chances to position your portfolio for great gains.
The best way to benefit: buy a small amount of stock in industries out of favor now such as the housing industry (only the strongest ones) or banking or industries carrying historically low P/E multiples (the above names are good places to start). Don't bet the farm on the big rally. But it is coming. Profits will surge once the economy starts to recover. Strong stocks, ones who have survived and thrived during this economic mess, will lead the big rally. It's the timing that's so tough to gauge.
- Ted Allrich
September 29, 2010