The Ultimate Signal to Load Up on Stocks?

Legendary fund manager Peter Lynch famously said that if investors spend 13 minutes thinking about the economy, they've wasted 10 minutes.

Granted, Lynch wasn't managing money during a mega-macroeconomic crisis of the sort we're facing today. Plus, Lynch was likely being funny and hyperbolic -- surely some thought to macroeconomic events is useful for investors. (Anyone thought about buying a bank stock lately?)

So when we read the other day that lipstick sales rose more than 4% in 2008, we nodded our heads. Here it was again: the leading lipstick indicator.

How lipstick explains the economy
The ... what?

The leading lipstick indicator, is a scientific measure of the sale of, well, lipstick. The theory goes as follows: When times are tough, women will purchase lipstick rather than purchasing new threads or splurging for a new necklace. During the Great Depression, lipstick sales reportedly rose 25%!

The term was introduced by Estee Lauder (NYSE: EL  ) Chairman Leonard Lauder, who created it with nothing more than years on the job and astute observation.

Of course, lipstick sales are a comically unreliable economic indicator and lipstick alone can't save Estee Lauder investors from a downturn in consumer discretionary spending. But the obvious absurdity of judging the state of the U.S. economy by sales of this single product should at least suggest that other market "indicators" that judge our economy by a single metric are equally dubious.

New home sales? New home starts? Jobless claims? Non-farm payroll numbers? Durable goods report? They all make for interesting morning segments on CNBC, but they're unreliable, subject to revision, and not worth much without loads and loads of context. That means they're nothing but obnoxious noise to the ears of long-term-focused investors.

Turning to Buffett -- who else?
So imagine our surprise when we read a Fortune piece a few weeks back with the following headline: "Buffett's Metric Says It's Time to Buy."

Would Warren Buffett -- the patron saint of fundamental-focused value investing -- really suggest broad market indicators are relevant to a buy decision?

As it turns out, it can be.

His signal looks at total stock market value compared to gross domestic product. In 2001, when the percentage was over 130%, Buffett said that "if the percentage falls to the 70% or 80% area, buying stocks is likely to work very well for you."

At the end of January, Fortune reported, the ratio was at 75%.

The ultimate signal to load up on stocks?
Not so fast. This is, after all, the same Warren Buffett who told Berkshire Hathaway shareholders that "We try to price, rather than time, purchases." He went on to say:

In our view, it is folly to forego buying shares in an outstanding business whose long-term future is predictable, because of short-term worries about an economy or a stock market that we know to be unpredictable. Why scrap an informed decision because of an uninformed guess? ... We have usually made our best purchases when apprehensions about some macro event were at a peak. Fear is the foe of the faddist, but the friend of the fundamentalist.

In other words, it's foolish to abstain from buying because stocks in general appear "overheated," just as it's foolish to buy willy-nilly because stocks appear "cheap." Investing the Buffett way (which seems to have worked out pretty well for him) is about bottoms-up fundamental analysis with a focus on long-term competitive advantages.

Which brings us to an analogy
But look, it'd be daft to ignore the fact that it's better to go fishing at some times of the day than others and that that optimal time of day is determined by the weather and moon. If you go out at the wrong time with the best bait, your chances of hooking a fish are diminished; if you go out at the right time with nothing more than hook and a string, your chances are improved.

Similarly, in investing, you're more likely to earn great returns if you buy when stocks across the board are cheap than if you try to find the one or two bargains at a time when stocks across the board are expensive. And that's why some macroeconomic analysis can be useful: It tells you the best times to go fishing.

And today is one of those times. As we mentioned earlier, the market is broadly trading for just 75% of GDP, and on an individual level, many of the market's most impressive companies are trading at enormous discounts relative to their norms:

Company

Current P/E

5-Year Average P/E

Google (Nasdaq: GOOG  )

29.5

67.1

Johnson & Johnson (NYSE: JNJ  )

11.6

17.8

Boeing (NYSE: BA  )

10.5

20.9

Intuitive Surgical (Nasdaq: ISRG  )

25.4

53.8

IBM (NYSE: IBM  )

11.3

15.5

Disney (NYSE: DIS  )

9.7

17.3

Data from Morningstar.

So, I buy those six stocks?
Now, this doesn't mean that all of these stocks will beat the market from here on out, but it does mean that now is a great time to go fishing for top stocks in your portfolio. If you're looking for some help doing just that, you can get the latest guidance and buy and sell recommendations from Fool co-founders David and Tom Gardner at Motley Fool Stock Advisor.

You'll also get advice on how to stay in the market for the long term, diversify for the best returns, and remain Foolish and have fun even amid this stressful market environment. If you're interested, we offer a free 30-day trial with no obligations to subscribe. Click here to learn more.

Already subscribed to Stock Advisor? Log in at the top of this page.

Brian Richards does not own shares of any companies mentioned. Tim Hanson owns shares of Berkshire Hathaway. Google and Intuitive Surgical are Motley Fool Rule Breakers picks. Berkshire and Disney are Stock Advisor and Inside Value recommendations. Johnson & Johnson is an Income Investor selection. The Fool owns shares of Berkshire Hathaway. The Fool's disclosure policy says that if you're looking for fishing advice, try arkansasstripers.com -- but be careful when typing in the URL -- it learned the hard way and ended up having a talk with our IT department.


Read/Post Comments (28) | Recommend This Article (181)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 20, 2009, at 4:41 PM, MORNINGSTARSCHOO wrote:

    JUST BEING FOOLISH IS NOT ENOUGH TO BUY ON

    LOOK FOR BIG GAINS

    IN SHORT TERMS

    LONG TERM BUYING IS FOR FOOLS

    WE ARE NOT IN GOOD TIMES AND WO'NT BE FOR A LONG TIME

    BUY FAZ

  • Report this Comment On April 20, 2009, at 7:45 PM, laogao wrote:

    Wow, SCHOO, you read my foolish mind.

    Got FAZ today at 10.20.

    Also stepped in to SRS.

    Agree that this is not a time to be accumulating buy-and-hold companies, unless you want to wait another 5 years to break even.

  • Report this Comment On April 20, 2009, at 8:42 PM, foolasia wrote:

    Good article. Where can we find a chart that tracks total stock market value compared to gross domestic product?

  • Report this Comment On April 20, 2009, at 10:11 PM, tomd728 wrote:

    The only thing I own in this environment is SDS

    and SKF.

    I would agree with all the suggested buys on this list

    and it would not be a stretch to find a dozen more...

    however the ETFs I list must play out first and if I'm

    right I buy those listed beauties with the House's

    Money.

    LTBH has to be re-defined for now...simply chart

    the list and we'll talk.

    Best to all Fools

    Tom

  • Report this Comment On April 20, 2009, at 10:22 PM, cindyandron wrote:

    it would seem to me that in times like these that buying stocks that actually pay dividends or share the rewards of doing business with the owners of the corporations are the ones that we should support. How did we ever get to the point that it was a good idea to buy stocks in companies that the managers who might not have ever risked any of thier own money want us to buy stocks that don"t share the profits with the owners? They seem to want us to just provide rewards to them for thier managemnet abilities.

  • Report this Comment On April 21, 2009, at 12:08 AM, olwreckdiver wrote:

    Wrong AGAIN, Motley. Just look what the market did today!

  • Report this Comment On April 21, 2009, at 6:59 AM, Varchild2008 wrote:

    "(Anyone thought about buying a bank stock lately?)"

    I bought BAC...After profiting over $2 Grand..... I switched to (TCB) and I am profiting over $100 not counting dividends on that one.

    Some other investors whose blogs I've read mentioned some other good banks:

    (ZION)

    Oops! That right... Richards and Hanson don't want anyone to invest in anything that makes people rich.

  • Report this Comment On April 21, 2009, at 9:26 AM, ReillyDiefenbach wrote:

    BRK at 89k, down from 148k.

    Whoops!

    Buy and hold RIP 2008.

  • Report this Comment On April 21, 2009, at 9:27 AM, ralphmachio wrote:

    Once again, opposite of Cramer Theory holds up like marvelous clockwork! As far as useful info is concerned, listen to the people who come here (not me neceserely), but not the management.

  • Report this Comment On April 21, 2009, at 5:14 PM, paultaut wrote:

    Then there is the Hemline Indicator which has yet to take a walk down the runway.

    Will the real forward looking Indicator please step to the front: Basic Materials.

    The Basics always lead because they forecast future Economic activity.

  • Report this Comment On April 22, 2009, at 9:30 AM, SkepticalOx wrote:

    "BRK at 89k, down from 148k.

    Whoops!

    Buy and hold RIP 2008."

    Uh yes, cause the stock price of Berkshire going down in a down market is an indicator of value buy and hold investing is dead, or that Buffett lost his investing edge, or that Berkshire is a bad company. Wow, I think, like, you so got a point. [That was SARCASM if you didn't catch it]

    You do realize that in the past year, BRK-A's performance has been beating the S&P500 right?

  • Report this Comment On April 23, 2009, at 2:05 PM, pete4357 wrote:

    "How did we ever get to the point that it was a good idea to buy stocks in companies that the managers who might not have ever risked any of thier own money want us to buy stocks that don't share the profits with the owners? "

    cindyandron - good point.

    I would like to raise a related point which occurred to me as I was reading the latest issue of Stock Advisor. Tom Gardner recommends his 5 best buys now yet HE OWNS NO SHARES in any of them. It was exactly the same last month. How much faith can he have in these companies?

    To be fair, i would like to congratulate the Fool on their disclosure policy which makes this information public. Also, David Gardner is much more likely to put his money where his mouth is: he owns shares in 3 of his 5 top picks both this month and last month.

    I'd love to hear a response from Tom or another SA staffer. Tom, maybe you are planning on buying some of your best buys? Where are you invested / investing if not in your 'best buys now'?

    Here's a quote from Tom from the latest issue:

    "the more of our recommendations you've bought, the better your chances to mirror (or beat) our success"

    When you aren't putting your own money on the line alongside mine, comments like that sound a little hollow.

  • Report this Comment On April 24, 2009, at 1:13 PM, fibreoptik wrote:

    I love how all the guys for whom short term, daytrading is attractive because of THEIR current situation chime in to BASH long term value investing as soon as the Buffett way is mentioned. Look. Not EVERYONE here is 60 or so years old and about to retire. Some of us are in our early 30s (or younger even!) and we have PLENTY of time to sit on some cheap positions in great companies and ride them to OUR retirement. Sorry you are not necessarily in the same boat but please don't tell me or anyone else that your way is the RIGHT way. For you, maybe it is. End of story.

    See you on the beach! ;-)

  • Report this Comment On April 24, 2009, at 2:43 PM, SkepticalOx wrote:

    To TradeNakedOptions,

    That "lost decade" of the S&P, etc., effects those who are indexing (though those dollar cost averaging might have done better).

    But value investing in the sense of buying companies that are significantly undervalued and selling them when they are fair/overvalued is not the same thing.

    And besides, the overwhelming majority of day and short-term traders have faired far worse than passive index investors.

  • Report this Comment On April 24, 2009, at 5:25 PM, dejayajay wrote:

    To Trade Naked

    If the market is at 10 year lows, that alone indicates that this is a good time to buy for long term holders.

  • Report this Comment On April 24, 2009, at 5:44 PM, jbrt wrote:

    whats the difference on gains ? a gain is a gain is a gain simply put YOU CAN'T GO BROKE MAKIN' MONEY

  • Report this Comment On April 24, 2009, at 6:20 PM, PetRock235 wrote:

    Dividend stocks, huh? Banks like BAC and C and WFC used to be dividend stocks, but you can't pay dividends with bailout money so they have cut dividends to a penny.

  • Report this Comment On April 24, 2009, at 9:06 PM, NolAloha wrote:

    This was a really funny set of posts. It seems like the short-termers are saying "This time it's different, long term is dead." I have heard that several times, and each time it has been both true and false. It is true for the short term, but false for the long term. I buy on price, potential and the attitude of management. Right now most stocks are on sale. Just for laughs, I put together a portfolio of 30 Master Limited Partnerships and 30 Preferred Stocks, The First in the middle of January, and the Second in the middle of March. Not counting dividends, the first portfolio us up 16%, and the second is up 40%. Luck? Not likely. There were only 4 losers in the entire group, They were selected on Price, Potential, and attitude of management.

    Contact me if you want the lists. No charge, no sales pitch. I don't need the money.

  • Report this Comment On April 25, 2009, at 12:30 AM, 69wisefool wrote:

    Dear Motley Fool question-answerers:

    I, sadly, have no idea of the dollar amounts of total stock market value "a few weeks ago," at "the end of January," and when this article was written, as well as the precise current GDP number, all off the top of my head. Am I the only one?

    In this 4/20/09 article (e-mailed late 4/24), you cite Fortune's 75% figure as of the end of January, then proceed to write: "As we mentioned earlier, the market IS broadly trading for just 75% of GDP, ..."

    Is "total stock market value" right now in fact nearly the same as it was at the end of January?

    If so, and especially if not, that would seem to merit a VERY CLEAR mention, especially given that the market has been very volatile in that time period.

    By the way, can you say how different the ratio was at the major indexes' bottoms this year (so far, anyway)? Did it dip significantly BELOW 75%? It would certainly give us a sense of how much market movement it takes to make X amount of difference in this ratio. Or maybe, "Currently, it would take X to change the ratio by 10 percentage points."

    Thank you for your patience. Sure, I could have closed out the article and researched all this, but it seemed a glaring omission to this apparently not-so-wise Fool.

    P.S. Good question, foolasia!

  • Report this Comment On April 25, 2009, at 6:49 AM, DaedalusAdvising wrote:

    laogao, looks like you're down 20% in just over a fe days. FAZ is a risky move...I'm up 102% on JDSU, (also a risky move), but I analyzed this stock for 8 years and 2.25 months. Good investing doesn't come with quick moves on fast advise. Do the due diligence then stay with your gut. It is a very good time to carefully buy equities but precious few stocks qualify. Pick the right one's and in a few years you will be happy you did :)

  • Report this Comment On April 25, 2009, at 6:54 AM, DaedalusAdvising wrote:

    You guys that are day or week trading are, (and will), lose your money. The house statistics are against you...you will never win treating the equities market like a roulette table :) Good "luck"...cause that's what you're betting on!

  • Report this Comment On April 25, 2009, at 11:46 AM, RiskAverseAlert wrote:

    Question: Was Warren Buffett investing back in 1930? I ask because, when the global financial system is hopelessly bankrupt (like it was then and is right now), you have what is called an analytical outlier. Now, granted, there still will be stocks that hold up in the toughest of times. Yet picking them in the midst of thousands of traded issues strictly will amount to an exercise in luck for most who try. Indeed, most companies whose balance sheet was on sound footing experienced a world of hurt 1930-1932. Likewise, it took a number of years for their stock price to recover. Such is life in a capital-starved world.

    Now, all one has to wonder is, if Doug Cass were around in 1930, would he be broadcasting his belief that a "generational low" had been reached in the stock market? Probably. And so, investors will ignore the hopelessly bankrupt state of the global financial system at their own peril...

  • Report this Comment On April 25, 2009, at 6:29 PM, freddyv3 wrote:

    I didn't ignore the economy in 2007 or 2000 or in 1982 and each time it lead me to tremendous success. I have easily outperformed Mr. Buffet for years and I do so by looking at everything and I can assure you that stock valuations will get lower and will stay much lower than most people are used to for a decade or more.

    None of that means there is not lots of money to be made even with a long position but one should not fight Dow Theory, the economy as a whole or the tendency of the market to revert to historic averages over long periods of time.

  • Report this Comment On April 25, 2009, at 7:06 PM, donjames911 wrote:

    Riskaversealert, you need to realize that the crash of 1929 resulted in major revisions to banking laws. The primary change was preventing banks from dealing in securities. Under The Clinton administration, with the help of the Republican-controlled legislature, these laws were reversed. Thus we have the latest banking crisis. Those who do not learn from history are forced to re-live it......

  • Report this Comment On April 28, 2009, at 10:35 PM, ganamide wrote:

    NolAloha, I started working on assemblying lists of MLPs, Royalty Trusts, High Yield Funds, Convertible Bond Funds, and Preferred Bond Funds. How can I contact you regarding the lists you compiled? I would be happy to share my lists once I am done.

  • Report this Comment On April 29, 2009, at 1:38 AM, bebop111 wrote:

    The Motley Fool actually (and finally) recognizes the importance of macroeconomic factors--this is a breakthrough! Maybe our Foolish portfolios would be in better shape today had MF had paid some attention to this before. Instead, all we got was "don't try to time," and "buy and hold."

    I'd really love to know the top Fools' CAPS ratings (or record against the S and P) for the last year. I'm pretty sure it's not something they'd want to advertise.

  • Report this Comment On August 13, 2009, at 9:50 AM, OutofFavor wrote:

    STOCK 4/20/09 8/12/09 % return

    GOOG 379.30 458.58 21

    JNJ 52.47 60.59 15

    BA 36.48 46.34 27

    ISRG 125.98 229.68 82

    IBM 100.43 119.29 19

    DIS 19.41 26.22 35

    FAZ 11.63 26.73 130

    SRS 33.24 12.167 -63

    SDS 70.401 45.34 -36

    SKF 70.45 29.122 -59

    BAC 8.02 15.93 99

    TCB 14.35 14.28 0

    ZION 12.93 16.23 26

    BRK-A 89000 101000 13

    C 2.94 3.98 35

    WFC 17.00 27.17 60

    JDSU 4.68 5.81 24

  • Report this Comment On November 22, 2009, at 3:42 AM, JibJabs wrote:

    "surely some thought to macroeconomic events is useful for investors. (Anyone thought about buying a bank stock lately?)"

    I did and I'm quite pleased. The Fool was very slow to get back on the bandwagon with banks.

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