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 Published
Monday, June 4, 2007
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Market rises 'on a wall of worry'
by Stephen Butler
We all need a friend in the box business.
Mine happens to be John Tatum, whose collection of companies
includes a fully-automated corrugated cardboard assembly line
that operates like something out of Willie Wonka and the Chocolate
Factory.
A slurry of recycled paper at one end comes out as fresh new
cardboard about 100 yards away. John says that cardboard box sales
are slowing down, and that's a forward indicator of future economic
conditions.
People who aren't shipping product stop buying boxes. Box orders
are the canary in the mineshaft ... the finger in the wind.
So why is everybody so bullish on the market when there are at
least some signs that the economy is cooling down maybe way down?
Ken Fisher, whose ads are everywhere, offers a convincing case
for why stocks are headed for continuing all-time highs. He points
out that they are cheap by historical standards because earnings
have been increasing faster than stock prices.
The counter argument here is that P/E ratios are now averaging
19 as opposed to the historical norm of 16 for the S&P 500.
We're now in the fourth year of a bull market. Fortunately, the
true believers in long-term market gains include economists independent
of the brokerage industry. The clarion call of "this time
it's different" is based upon the emergence of a world economy
and what appears to be its unlimited appetite for growth.
But when it comes to the pundits, Alan Greenspan, in a speech
in Japan last month, said that he expects a slowdown in our economy.
In his newsletter, Bob Brinker talks about his expectation of
a "correction" of at least 10 percent (but not 20 percent)
and the fact that this will provide a nice buying opportunity.
Then, the Wall Street Journal points out that short-selling is
at an all-time historical high. Right now, 3.1 percent of all
outstanding stock on the NYSE is borrowed and then sold with the
hope that it will go down in price with the borrowed shares returned
after being bought at a cheaper price.
The short seller pockets the difference between what he or she
received after selling the high-priced borrowed shares and the
reduced price they will be spending later to buy replacement shares
at pay-back time -- assuming the market goes down. Short selling
at Nasdaq also hit an all-time high in May. Some reasonably smart
people running those hedge funds are convinced that stocks will
be heading south.
Here at home, we may have to come to terms with a struggling
economy, but it may not impact our investment portfolios to any
great degree. If this sounds a little antithetical, an economist
with a sense of humor once pointed out that the stock market has
predicted "nine of the last five recessions. "In other
words, the economy and the stock market don't always operate in
lock step.
With a dollar declining in value, large U.S. companies with substantial
overseas sales and facilities will sell more, retain value and
increase profits.
The average S&P 500 company derives one third of its revenue
from overseas sales. This helps to explain why money is pouring
into large-company, value-oriented mutual funds. At the same time,
a number of independent asset allocation advisory firms are recommending
that one-third to one-half of everyone's portfolio should be in
foreign and emerging markets funds.
Over the past several months, $600 billion in assets has moved
in that direction within the mutual fund industry. In the same
period, only a net gain of $30 billion was experienced by domestic
funds. Our money is fleeing the country.
The market rises "on a wall of worry." If you are confused
and/or worried about these conflicting signals, you're normal.
The antidote is stay diversified with money spread out over several
different investment types.
With large company value funds, you're already one-third invested
overseas automatically, and you can look forward to receiving
dividends. This is definitely not the time to flee the market,
but with as much uncertainty as there is today, bumping up the
bond fund portion with some GNMA funds wouldn't be a bad move
for someone who is closing in on retirement.
As to the forward-indicating box business, our economy doesn't
yet feel like a house of cardboard. Everyone I do business with
is making good money and hiring more people, but we shouldn't
be surprised if it all falls off a cliff in, say, 2008.
If the economy slows down, our incomes might suffer, but a collection
of diversified investments could continue to hold up. Should this
be the case, today's wise move would be to cut back on some discretionary
expenses, clean up some debt and bump up those retirement plan
contributions.
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