Struggling Stocks, Booming Commodities
04/28/2005
NASDAQ dropped -12.5% year to date in 2005. S&P500 index suffered -5.7% this year. US stock market has been terrible over past few months.
Not only general market is down, oil stocks recently had a significant correction as well. It is easy to be nervous because of the short term setback. However, to succeed with long term oriented value investing, we can not be distracted by the volatile short term market movement. It is time to step back and look at the big picture of the current stock market and review investment strategy to profit in this kind of tough environment.
Stocks in General and Oil Stocks
Below chart is past 1 year performance chart between Energy Index ETF (ticker: XLE) and S&P500 index (ticker: SPY). By looking at the chart, even a fool will know that oil market is booming while US stock market in general is struggling.
Simply put, the current US stock market is not in bull market. The heydays of 1980's and 1990's when anyone can simply put some money in S&P500 index fund or a decent US mutual fund to earn 10% to 20% plus annual performance is long gone. I expect for the next 8 to 10 years, the US stock market in general will be stagnant.
If you have believed that 20 years of stock market performance between 1980 and 2000 is stock market average performance, then you will be shocked to know that just before that period in 1960's and in 1970's, US stock market went nowhere. Dow hit 995.15 in 1966 and Dow was back to 800 in 1982. If you were the long term investor who invested in Dow index fund between 1966 and 1982, you got a negative -20% return overall for your 16 years of loyalty, how would you feel about that ?
Still remember the NASDAQ peak of 5000? In my opinion, NASDAQ is screwed up index with full of expensive stocks even today. I predict that we may have to wait another decade to revisit NASDAQ 5000.
Current Stock Market Average Valuation is Not Cheap
Currently SP&500 index trades at about 17x average PE today. Although this valuation is not terribly expensive, it is not that cheap either.
Over past 100 years of US stock market history, market usually bottomed at average PE of 10. That happened in 1974 or 1929 or 1980. We are not there yet, not even close over past 5 years even though the technology stock bubble bursted in 2000. In a major stock market bottom, we should see plenty of big cap stable companies trading at PE of low teens. Now look at this: Coca-Cola (KO) PE 20, Walt Disney (DIS) PE 24. Even worse, a no-growth stock like Sun Microsystems (SUNW) is still trading at premium PE of 19.
What is the Overall Earning Outlook of US Stock Market?
Even though the current stock market valuation is not that cheap, if earning is good, market should do fine.
Are we going to get excellent overall earning outlook in the next few years for the US stock market in general? Unfortunately, my answer is no. My take is that US stock market earning overall is decent, but not good enough to trigger a bull market. This market is still digesting the past bubble over-valuation coupled with poor earning outlook.
Here is one reason of my not-so-enthusiastic earning outlook: the rising oil and commodity prices.
The Booming Commodity price
Commodity and oil market has been booming since 1999 and the high commodity price is taking toll on overall stock market earnings. Companies need to pay more for the things needed in business: steel, copper, oil, natural gas etc. Historically, when commodity market was shining, stock market did not do very well, and vice versa. In 1960's and 1970's, oil and commodity had bull market run for nearly 20 years while Dow Jone index had horrible performance for nearly 20 years. From 1980 to 2000, the stock market soared while oil hit as low as $15.
The Bull Oil and Commodity Cycle Could be Very Long
Jimmy Rogers is famous investor who co-founded Quantum Fund together with George Soros. In his recent book titled "Hot Commodities", he is predicting that the current commodity bull market can last until 2013 strictly due to supply and demand.
In one chapter of the book titled "Goodbye, Cheap Oil", he clearly lays out the reasons why oil and natural gas bull market can last until next decade. This is as simple as supply and demand: rising demand coupled with declining supply.
The supply of oil and natural gas was diminished partly due to extremely low oil and gas price in 1990's. Over past 35 years, there was no major oil discovery in the world while the old oil fields deplete. Oil and natural gas production level of a well does not stay flat over the life of a well reserve. The production level of a well actually declines gradually due to geophysics of oil well until the reserve is fully depleted. Even there is new oil field discovered, it will take a decade after the discovery to actually produce oil! Increasing supply to meet demand is a very difficult and slow process.
Coupled with declining supply, the demand of energy from China doubled since 1990 consuming 8 percent of world's oil in 2004. US economy is growing with increasing oil demand year over year while US oil production has seen sharp decline over past 50 years.
Still the oil price is not that high on historical basis. Even with today's oil price of $50 a barrel, the oil price is still significantly lower than the inflation adjusted peak price of $90 a barrel in 1970's.
Value Investors Do Not Need a Bull Market to Make Money
As scary as the potential trouble in stock market, this kind of tough environment is great money-making time for value investors to pick up cheap shares.
Warren Buffet is the greatest value investor in the world. He averaged 20% annual investment performance over past 50 years. However, Mr. Buffet's performance in bear market of 1960's and 1970's was actually 30% per year return, much higher than his average performance.
Focus on Dirt Cheap Stocks and Booming Commodities Market
Stocks do not go straight up or go straight down. There will be huge run up or sharp sell off in short term. While market is not in good shape, this is and will be wonderful time for long term oriented value investors.
Commodity price is volatile. Just like stock market, commodity price does not go straight up or straight down. Although oil price weakened recently, I firmly believe that oil price is not going back to cheap oil price below $40 a barrel. As long as oil and natural gas prices stay high, oil stocks will do fine in its business. As painful as the recent sharp sell off in energy stocks, energy stocks in general are still very cheap and my investment strategy is to continue to stay long term oriented in them.
In the short term, it is very hard to know when a stock will go up or go down. But I do know that valuation and earning matters and investing in cheap stocks trading significantly below market average will be rewarding in the long run.
Article by Henry Lu of BlastInvest LLC, a premium investment newsletter publisher in Connecticut. Visit http://www.BlastInvest.com for FREE "how-to" investing assistance, web services and more.
More Resources
Unable to open RSS Feed $XMLfilename with error HTTP ERROR: 404, exitingMore Stocks & Mutual Funds Information:
Related Articles
Selling Strategies - Setting a Stop Loss
Sometimes the best way of lowering exposure to risk is not to invest at all! However, when we make the decision to jump into the muddy waters of the stock market, its always a good idea to have a life jacket ready, just in case.We all have stories of that "must have" "can't lose" stock that looking back, we didn't really need to buy, and it definitely lost.
Mutual Fund Commissions
You have heard about a particular mutual fund from a friend, saw it advertised on TV or read about it in some publication thought it would be a good buy. Next you call your broker to get his advice before you buy because he is an expert and is there to help you make money.
No Load Mutual Funds or Exchange Traded Funds (ETFs)?
If you are fed up with early redemption charges and ever increasing mutual fund management fees on top of bad-performing fund managers, read on. There is a quiet revolution going on in the no-load mutual fund industry and you, the individual investor, may benefit from it greatly.
This Market Is Different
All of the talking heads have been telling us that this market is different. You are going to have to be patient and soon (hopefully in your lifetime) the DOW and the Nasdaq will be back at their old highs.
Investing Basics - Stocks, Mutual Funds, Real Estate & Online Investing
Have you ever thought of investing? Do you have a family that you would like take care of? Does the idea of making money with stocks, bonds, mutual funds and real estate interest you?Investing is essential to making money. Whether it be stock investing, investing online, real estate investing, finance investing, investing in bonds, investing in mutual funds.
Complacency
During the month of January the Dow Jones Industrial Average, usually referred to as the DOW, had an almost 1,000 point range, most of it down and the average investor has yawned and said 'so what, this has happened many times before'.Is there any reason to worry now?The terrible event of September 11 shocked investors who sold heavily and then watched the market climb back to where it was on September 10.
The Seven Mistakes All Novice Traders Make and How to Correct Them
We learnt the following the hard way! If any of these things applies to you, don't worry - there is an easy solution!MISTAKE ONELack of Knowledge and No PlanIt amazes us that some people expect to trade the stock market successfully without any effort. Yet if they want to take up golf, for example, they will happily take some lessons or at least read a book before heading out onto the course.
Its Better
Question: How does it get better when it gets worse?Last week we had a jobs report from Washington that there were fewer jobs created than they had anticipated, but the stock market took that as good news and the DOW had a strong rally. WOW! The bad news somehow turned into good news because the unemployment rate dropped one tenth of one percent.
Long Term Financial Vehicles
Investing in long-term financial vehicles give you the most gains but it also puts your funds at greater risk. There is much truth to the saying, "there is no gain if there is no risk".
Analyzing Growth Stocks: An Important Focus For Any Investor
Analyzing growth stocks is an important focus for any investor. This is especially important, since stocks are an irreplaceable part of any good investment plan, and since unbiased stock research is hard to find.
Stocks: Understand What You Buy!
"There is nothing more frightful than ignorance in action!" Johann Wolfgang von Goethe (1749 - 1832)I don't really know how cars actually work. Not really! I know how to drive them, but if you asked me how they work, I would not really know how to definitely explain it.
True Investment Road Maps
If you don't know where you are going any road will get there. After you get there you might not like where you ended up.
Gold Fever
Right now there doesn't seem to be any "gold fever". Very few are out looking to strike it rich in this sector.
Enron Cure
Let's hope you did not have any of the Enron stock. Maybe you know someone who did and lost everything, but you certainly might know several people who owned stock that lost almost everything.
What Can Model Airplanes Teach You About Trading?
I was devastated!I just couldn't believe it. I was 10 years old and my dreams were shattered.
Top 25 Growth Funds
On Monday, November 25, 2000 Investor's Business Daily listed on page B1 the Top 25 Growth Mutual Funds for the last 36 months along with their performance for the year 2000 to date. Only four showed a profit this year of 21% and the other three had increases of 12%, 5%, and 5%.
Do You Know What is the Single MOST Critical Mistake in Trading the Stock Market??
Well maybe that's overstating it a little, but it's certainly one of the most important.It is?(drum roll please)? "the need to be right"!Now that probably wasn't what you were expecting.
Market Timing?
The recent criminal fiasco in the mutual fund industry is being used by Wall Street to persuade investors that market timing is a bad thing. The late trading by Janus, Bank America and several other well known mutual funds is falsely being called market timing.
Economists #2
Economists know more about how the fragments of society work than anyone. In school they are taught to break down the economy into its tiniest parts and to quantify each minutiae so it can become part of a formula.
How to Find Value in No Load Mutual Fund Investing
What are you thinking when it comes to your no load mutual fund selections? Are you saving pennies and sacrificing dollars?Are you spending your time looking at expense ratios, analyzing Morningstar ratings and searching for funds with low fees and no 12b1 charges? If you are like most people, you know these things in and out. You've spent hours evaluating them, and your chosen mutual funds cost little to purchase and maintain.