THIS IS MY 165TH BLOG ON UNDERSTANDING MONEY
TOOLS
May, 2019
In this blog we are going to take another look at the
markets, concentrated on stocks. If
you have read any of my blogs you know that these markets have “boggled” my mind for several
years now, as they have not conformed to historical reasoning, especially
value.
In the past couple of weeks, getting together with two
separate individuals we discussed the reasoning behind these markets, with a
better understanding of why they may be at these elevated values.
Friends of mine from the Netherlands invited a couple from
the Amsterdam area to vacation and stay at their home in my town. This man is a respected, wealthy
M&A (Mergers and Acquisitions) person doing business worldwide, and
especially in Europe and China.
Concluding our discussions two facts hit home; 1) most countries like
the US have printed money like crazy over the past 10 years, and 2) the fact
that companies don’t need to show profit anymore or make sense to raise
billions, but there has to be a good “story”….e.g. Lyft and Uber’s recent
Initial Public Offerings. I doubt
if they will ever turn a profit!
They raised billions!
The second person I got together with is a long time friend,
who is quite smart, retired and has a master’s degree in engineering. This person I respect especially asking
questions as his background is not in finance, but was with a major company he
built up and sold.
As I want to cover several topics, I will go back to a
question and answer format to cut down wording. As always, I hope you learn a few things from this blog.
Question: Are
the major stock markets too high?
Answer: One
would expect so. With government
manipulation we have given privileged companies and individuals incredible
borrowing capabilities to avoid recession. A recession would normally be
expected in a free market society every 6 to 8 years. The only times in history that the stock markets were so
over priced was in 1929 and 1999.
Money is pouring into the markets.
Question: Is
inflation a concern in the Gross Domestic Product valuations?
Answer: It
depends on whom you talk to.
Again, there is tremendous manipulation. There is “real” GDP which the government should use to
calculate inflation that takes into account inflation, but there is also
“nominal” GDP which has been used and doesn’t factor into inflation. When the government states GDP it is
supposed to use “real” GDP, but they put caveats into the statement like not
using agricultural (food) products nor oil/gas/energy products, thus usually
making numbers look better.
Question: Why are the markets so high, and why does the
government concentrate on keeping the markets at all time highs? Using things like the “Plunge
Protection Team”?
Answer: With
this answer I will give facts, and also some speculation. The answer is lengthy, and not easy to
define. First, the government has
been printing money like crazy, so there is a ton of money chasing few good
investments. The money has not been spread equally to all, thus leaving out
much of the middle class and poor people.
Many poor would not be investing even if they had money. ($4 trillion printed after the
housing/bank debacle in 2008-10 alone).
Let’s look at this from another standpoint. On August 15th, 1971 President Nixon and Congress
approved the United States to go off the gold standard, onto the “Fiat”
standard (the word of the country is good enough!).
I looked up the collateral behind the dollar then and
now. Back in 1971 an ounce of gold
backing the US dollar cost $40/ounce.
Today, gold is priced at $1,285/ounce. I then checked out the amount of M-1 today (that is cash,
savings, money markets and checking account money….quickly liquid). That amount in the USA is just under $4
trillion, and without our country being an avid purchaser of gold, like China,
this results in 17 times more dollars over the gold standard today than in
1971.
Now, with all the printing of money why hasn’t the dollar’s
strength gone down significantly?
In today’s world, I am sad to say, we still remain the strongest of
world’s weak economies. Our stock
markets are strong.
Further adding to this question you must remember Mr. Trump
is one of the greatest promoters of all time since Adolf Hitler and Barnum and
Bailey Circus. When he was elected
the DOW stock index rose about 7,000 points, not so much from corporate growth,
but from reduction of taxes paid by corporations and the wealthy. I want to override a comment Mr. Trump
made on May 15th that we are the greatest economy in the world, and
China’s economy is suffering. Yes,
we are the largest, however China’s economy is the fastest growing in the world
bringing 300 million people into the middle class sector in the last 10
years. Currently, China accounts
for 27% of the world’s economy whereas the US is 12%. China’s GDP did drop from 8% growth to 6.5%, however we have
had a struggle to keep our growth above 3%. China also owns us! They own about $1.3 trillion of US
Bonds, and our economy could never sustain if they wanted to sell these into
the world market.
Another angle.
In about 2008 the DOW Index was at 6800, today at 25,900, and yet
companies of goods and services have averaged growth of 3% per year. Assume you are an American and you had
$100,000 in stocks on the DOW Index back in 2008. Today, assuming all equal, you would have about
$380,000. If you went to your bank
and pledged your good stock to a loan a bank would likely lend 50% of
value. In 2008 the bank would have
given you $50,000, and today give you $190,000. Americans have used this to buy homes, cars, etc. and become
debt ridden. They also have
invested in the stock markets.
Younger people have never gone through a recession, therefore thinking
this is how the world, stock market and economy works…wrong!
Question: What
are methods for looking at stocks and making determinations of value?
Answer: For
value investors: The most reliable
is profit from corporations, or pre-tax earnings. Let’s use the DOW again. I subscribe to a service that gives me financial figures on
most exchanges, updated every 15 minutes.
I like the price to earnings ratio for companies and indexes. At the moment (May 16th), the
DOW is up, and at 25,915. It has a
P/E of 27.45 and the yield (or dividend is 2.13%). It has traded 171 million shares, at mid-morning. A person needs to pay attention to all
these figures. First, Price to
Earnings (P/E) is 27.45 which means that it would take you 27 years to get your money back if you invested in a
company with such a ratio. What is
the return on investment? Divide
the 27.45 into 100 and it is 3.6%.
The historical average people want is closer to 7% per year. Okay, to get to the norm how do I
calculate where the DOW should be if I want 7% on my money, considering risk on
stocks? Easy, whether it is the
DOW Index in this example or any stock.
Take the market price of the DOW at 25, 915 and multiply times the
standard of 15 (that is determined by taking 100 and dividing by roughly 7,
because of 7%). Now, divide that
number by the P/E of 27.45 above.
Voila! The DOW should be at
14,161, not where it is today.
For “Momentum Investors” it is the upward trending daily
volume of trading, more people buying than selling.
Question: What
is Projected Price per Earnings Ratio (PP/E)?
Answer: Many
times brokers will state this. It is the projected earnings at a given point
down the road.
Question: What
is a “peak” and “trough”?
Answer: The
peaks are the highs that a stock or index hits. The troughs are the lows. We can look at this viewing “moving day averages”, or
individually establishing a chart.
Right now the DOW Index range has been hitting high peaks at 26,000, and
low troughs at around 23,000.
Usually, after 3 of each of these moves the markets should make an
adjustment. This means that we
could have a break out of the DOW good for another 2,000 to 3,000 points
higher, or break through the trough and go lower. Make sense? My
view is what reasoning would make the market go higher when we are already
extremely high, and the projected second quarter GDP to be lower?
Even though I have covered these subjects thoroughly in past
blogs, it doesn’t hurt repeating.
These are so important in the process of making money in stocks, buying
companies and investing. I hope
you learned something.
In summation, it appears that the markets have become
accustomed to using momentum investing and using a PP/E, getting ahead of
reality. You will find this more
common on the NASDAQ exchange. Or,
perhaps it’s just “supply side” economics, where there is too much money
chasing too little product?
