From the December 2011 issue of Investment Advisor • Subscribe!

November 28, 2011

A Better Day

Imagine you’re given the choice of two different times to be a stock market investor. For the purposes of this mental experiment, let’s assume that the S&P 500 represents the stock market investment in this example.

On the day of your first choice, which we’ll call Option No. 1, the conditions are as follows:

  • Over the previous 10 years, the S&P 500 has gained more than 350% and is up nearly 18% in the last year alone.
  • The stock market is generally expected to continue to do quite well.
  • The S&P’s P/E ratio is around 31.
  • The prime rate, the interest rate charged to the most credit-worthy borrowers, is 9%.

The conditions for your second choice of when to invest, Option No. 2, are a bit different:

  • The previous nine years have seen the S&P 500 cut in half, plunging more than 47% in just the last 12 months.
  • Fear is rampant, and little hope is held out for the stock market.
  • The S&P’s P/E ratio is around 24.
  • The prime rate is 3.25%.

When would you rather be an investor?

If you haven’t already guessed, the conditions described above are those that actually existed in our not-too-distant past.

Option No. 1 is March 24, 2000. The roaring bull market of the 1990s fed the euphoria of early 2000. Many investors became increasingly aggressive, abandoning more conservative investments like bonds in favor of high-flying “dot-com” darlings. For those who gave in to the temptation to chase the bull market higher, the timing couldn’t have been worse. If you chose Option No. 1 as your entry date, what you bought was the investment experience that led to the conditions described in Option No. 2. Over the next nine years, the S&P 500 fell from 1,527 to 683—a 55% decline. March 2000 ushered in the stock market’s “Lost Decade,” culminating in the global financial crisis and market meltdown of 2008–2009.

Option No. 2 is March 6, 2009. The collapse in housing prices triggered a banking crisis, which spread to a global credit crisis. The world’s financial system teetered on the brink of an abyss. If you chose that day to plunk down your hard-earned cash, you ended up buying a market that would go up by more than 65% in just over 2½ years.

Where are we today?

On Sept. 30, the S&P 500 closed at 1,131.42. It is down for the year and virtually unchanged since December 2009.

According to Investors Intelligence, only 37.6% of advisors are bullish on stocks, and the Investment Company Institute reports that investors pulled nearly $71 billion out of equity mutual funds during the third quarter.

There’s a whiff of panic in the air.

The concerns weighing on the market are legitimate, but investments have a history of fooling investors into making mistakes—especially when emotions are running high.

Could investors be zigging just when they ought to zag? More than 22% of the stocks in the S&P 500 and one-third of the stocks in the DJIA are selling for P/E ratios of less than 10 based on their trailing 12 months’ earnings. The yield on the 10-Year U.S. Treasury Bond ended the third quarter at 1.92%. The dividend yields on the S&P 500 and the DJIA ended the third quarter at 2.2% and 2.8% respectively.

Today’s abundance of companies selling for single digit P/E ratios seem to offer a better option for investors than those that prevailed 11 years ago when stocks were wildly popular and selling for P/E ratios nearly three times higher.

How can you be certain that a particular turn higher in a market is the beginning of a new uptrend and not just another false start? The answer, of course, is that you cannot know for sure. What you can do, however, is remain vigilant in the search for value, invest when prices begin to turn and place the safety net of a trailing stop/loss under each position to try to capture gains and limit losses.

Gary Stroik, CFP
Vice President/CIO
WBI Investments Inc.

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