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Fair Value Is Here, But Watch Out Below
Friday, March 6, 2009, by Stathis
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The stock market (the DJIA) is now very close to fair value from a long-term perspective (if that even means anything to an individual investor, which it may not). Those who read “America’s Financial Apocalypse (the original expanded version) will recall that at the time (2006) I demonstrated how the fair value was around 6200. But fair value doesn’t mean the market won’t go any lower. It’s likely to fall considerably lower. I’ll explain below. I decided to do a Q&A format so I can cover more material in less time.

How much lower could the Dow fall? Virtually no level below 6000 would shock me other than below 3000.
 
What is most likely? Who knows? Things change daily. Right now, in a best-case scenario I see Dow 5800. The most likely scenario would be 4800-5600. I’m trying to be optimistic, but I fear we will see Dow 4000s, maybe lower. Remember, reversion to the mean almost always includes overshooting the mean. In other words, the stock market is likely to head considerably lower.
 
When will the market bottom? Who knows? If you want my guess, I would say sometime in 2010, maybe 2011. The point is that I would not expect a bottom to be made in 2009, unless we see massive sell-offs from current levels (unlikely right now)How much lower could the S&P fall? The S&P 500 still has a way to fall before it reaches fair value in my opinion. Based upon my forecasts for earnings, I would say 550 is fair value. Assuming it overshoots, I would expect to see 450-500.
 
What should you do? If you are a long-term investor, you should gradually start buying into the market in small increments. Only the best names, companies with little or no debt and market leadership; companies that pay cash dividends; dividends that are relatively safe (check free cash flows, debt levels for starters). That means buy slowly with small amounts with no rush. If you are already fully or majority invested, save your cash for a day when the last thing you want to do is buy stocks. That will be the day to spend your last dime buying. We certainly have been gaining steam towards that end. The problem is that a continued 2-4% sell off each day doesn’t by itself instill the kind of fear that brings the big money it. I’d like to see a 6-9% loss day from here. If you see it, chances are it will be a big day to buy.
 
What is a long-term investor? Someone with an investment horizon of at least 15 years, preferably 20.
 
If I think it’s going lower, why am I telling you to start buying? If you try to pinpoint the bottom, you will miss everything. 
 
Will we see a rally? Of course. When? I would say a rally could come soon. But once again, no one knows. Anyone who claims to know is a fool. You have to take things day by day. I’d expect such a rally to be triggered by some relatively trivial news or data set. Wall Street will make a big deal over it looking for an excuse to rally. The forces in play are setting up for a rally. Focus on market psychology and don’t waste time on this VXN and VIX rubbish…..they are coincident indicators. Technical analysis is fairly useless right now.
What happens if you start making money soon after you buy, say if a rally occurs? Sell, sit back and be patient. Let more bad news come in and see how the market reacts.
 
What about investors already stuck in the market with investment horizons less than 15 years? All you can do now is pray. You should have securities that pay nice dividends. Remember, if a stock doesn’t pay dividends, it’s only worth what someone is willing to pay for it. It’s similar to artwork. I don’t care what anyone says. Dividend payouts provide a real return on investment. Despite the terrible price paid for Wyeth, I still like Pfizer at these levels. I’m pretty upset at management’s selection of Wyeth and I got stuck at $15. Until it moves I’ll sit back and collect the dividends. Once I get out I don’t plan to buy PFE back until I see some real results. I also like Unitedhealth (although there’s no real dividend). Those who bought it after I kept recommending it several months ago hopefully took profits by now. If so, you should consider reloading. There are several others as well like Alcoa and Dow Chemical. If these pop, take profits and take a wait-and-see approach. I do not foresee these two getting much worse. Debt levels appear to be manageable. DOW might be on the hook for a big breakup from the ROH deal but I’d say that’s factored into the price. However, anything can happen. Have a look at the financials and you decide. Throughout your “bargain-hunting” binge, keep this in mind. As I warned several months ago, we are going to see several big name companies join the list of hundreds of other that will file for bankruptcy. Things are worse than even I predicted, so be careful.
 
What’s a big name that no one has talked about that seems to be in deep trouble? You all know I recommended shorting the banks, mortgage and homebuilders over 2 years ago. I also warned about GE and GM two years ago. And I reiterated that all throughout last year. Those guys are old news now. The smart money won’t touch them either short or long because there’s too much uncertainty. But has anyone said anything about CAT? Have a look at its financials. Over $35B in debt, with more than 75% of its business overseas, CAT is going to face some REALLY big problems, especially when the commercial real estate market fully collapses. I expect that market to tank worse than residential.
 
What about the oil trusts? I still like them but as you can appreciate, they too face potential problems. 
 
Where is oil headed? I’m surprised oil is holding the 40s. I would say most likely in the mid-20s, but don’t count out the mid-teens. Of course, oil is near impossible to call due to the manipulation on the futures market and OPEC. If oil does fall to the mid-teens, you won’t find many oil trusts that will be able to pay dividends. These trusts should be focusing on paying off debt. After speaking with the IR of one of the oil trusts, I was shocked at their lack of understanding of what is going on. They only follow the futures market, which is a myopic approach. Still, as a group, in my opinion the oil trusts are still one of the best risk-adjusted investments in the market right now. Once again, they are for investors who want a long-term source of income (not guaranteed). Those who have held them the longest know this, as their cost basis is likely to be 0.
What else is noteworthy? The UK is in deep trouble and might even have to declare bankruptcy before this depression ends. Eastern Europe is in even worse shape. Meanwhile, the IMF won’t be able to help much without some type of recapitalization, probably from the USA. That means all of Europe is in trouble. But we cannot forget Russia either. As bad as things are in America, as long as the dollar remains the universal currency, things won’t get as bad as in Europe. I still believe the dollar has not made its lows yet, but it won’t face the kind of butchering as the Euro and Pound. If it did, I would expect America to go to war. The dollar might hold strength for a while, but once the dust starts to settle in a few years, the inflation bug is likely to smash it. Keep in mind that I don’t deal with short-term currency forecasts. I only look at trends to help me forecast global equities and bond markets. Of course the problem is that the further out your forecasts are, the higher chance they will be wrong. 
 
What’s the future of the Euro. I’m sure many of you will disagree, but I have always felt it won’t last due to the problems with destruction of individual sovereignty of each member. The global depression has magnified these effects. I would be surprised if the Euro was still around with all current members after 2020. If either Germany or France defects, it won’t last.
 
As discussed many times, I still like Brazil and China down the road (in that order). When signs of recovery begin, America is likely to demonstrate a fictitious recovery (unless it is the aftermaths of a war). The recovery in Brazil and China will be real. Certain nations in the Middle East will be the least affected by the global depression but I certainly wouldn’t invest there. Be patient. There is much more bad news to come. When the US seems to be on the road to recovery, I’d be looking to Brazil and China. 
 
You should note that in the past I have been extremely accurate calling market sell-offs. My record is online. You should also note that this is the first time in over three years I have issued a market buy. But once again, you should only consider buying if you are a really good trader or your investment horizon is long. And you shouldn’t rush in. Buy in gradually as the market makes new lows. Maximizing liquidity is essential, so you are best positioned if you trade short-term.
 
When will we see capitulation? This market is not likely to show a typical capitulation, triggering the next bull market. The next bull market is likely to come over the next 12-24 months due to what will end up being much more government money pumped into the economy. However, this potential bull run will be short and will likely have a large correction. When you see signs of the rally, jump on board for the ride. But remember it won’t last so look for signs when to bail. I’m really going out on a limb here, because it’s so far off and it relies on many more stimulus and bailout packages, as well as the timing of thousands of events. One thing you can be sure of; there WILL be many more bailout packages and stimulus plans as I first predicted in the summer of 2008.
 
 
 
 
 



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