W e are in a market well down from its highs. As investors and professionals, what should we be doing ourselves and telling our clients to do? Let's use the S&P 500 as a measurement.
The S&P has had seven large declines since its inception in 1957, not including the present one. The average pullback has been 30.5%. Down-legs can be lengthy, with some lasting as long as 21 months.
So if history is any guide (and often with the markets it is not), with the S&P having gone down 30% and now down about 18% there is a strong case for buying stocks, particularly from a value and bargain-hunting basis.
As for valuations, this newly sober market is turning again to P/E ratios. The P/E multiple on the S&P 500 is now about 25. Since 1967, the average multiple on the index is 16. So one could say the index is still rich, overvalued by about 30%.
But the S&P 500 is not what it once was, and is entitled to a richer valuation. Technology--which comprises a much bigger part of the index, about 19%--has a higher multiple than most others. So now the S&P 500 is more growth oriented, which creates a higher multiple.
Technical analysis also suggests the bottom may not be that far off. Markets often retrace to the high of the previous bull market, the point before that bull entered a bear phase. In other words, the market gives back all of the advances of a bull market run, but finds support in the prior bull market's high point.
If you draw a line on the S&P 500 chart, connecting the start of this bull market in 1982 through its end in 1998, it appears that the index would have to retrace back to about 950-975 to meet that long-term trend line. Although that possibility is rather dire, the index is not that far off now, standing at 1266.
The market could go lower, and the next upward cycle could take years to develop. But the time to buy--the time of best value--is when the markets are down and people don't want to buy stocks.
Moving to the Nasdaq, since 1971, whenever Nasdaq engages in a bear market period it typically gives up 61% of the prior bull market advance. In this decline it gave up more than that.
In the past bull cycle, most investors were loath to accumulate stocks, preferring to rush in or out, depending on market momentum.
In that hypercharged volatility it made little sense to buy and hold; that market made traders of us all. But an upside momentum trading atmosphere is not prevalent now. An old strategy--accumulating stocks on weakness to hold for the long term--makes sense.
Before the market makes a sustained upward turn, perhaps it will take the passing of interest in Alan Greenspan's intent; the phasing out of so many TV financial shows; the cessation of politicizing market gyrations. My best guess is that there will be more down days followed by a long period of sideways digestion before the market advances again, perhaps over a period of years. But that is when money is made--when you buy stocks cheap, especially in groups that could lead the advance.
One sector that could do well is semiconductors. A good way to participate in this area is through the Semiconductor HOLDRs (SMH). The HOLDRs are down about 50% from their highs; SMH is selling at around 25 times forward year's earnings, based on a market price of about 40. Forward earnings for this sector will be down next year. Once capital spending rebounds, perhaps next year, the earnings of this sector could rebound sharply. There is risk here--if capital spending does not increase, there could be multiple shrinkage--but we think the risk/reward ratio is in balance or even favors the bulls.
For stocks in this sector, we think that Applied Materials and Intel offer the best value. Another value buy are members of the PC group. Dell Computer at 32 times earnings, and Compaq (CPQ) at 30 times earnings, can be bought aggressively.
Accumulating here, and now, could pay off later.