Was That the Market Hitting Its Peak?

It's worth wondering whether someone in March, for the first time in Wall Street history, rang a bell signifying that the market had finally hit a bottom.

I certainly don't think they did. And if they did, no one was kind enough to let me know that we had reached the market's nadir on March 6, with an ominous intraday low of 666.79.

We can ask a similar question today: Will someone let me know when we've reached the top of the little dead-cat bounce that we're experiencing? Please do. Because I'll figure out how to make another 40% on top of the gains the market has given me in the last two months.

Just give me a sign!
Here we are today, up nearly 300 points from that early March low, wondering whether we've just reached another market peak. Surely there's plenty more negative news to come. Everyone's sitting around waiting for this particular rally to fold, asking questions like "Where will the market go from here?" "Will it continue to regain some of the past six months' epic losses?" or "Will it revert back to or below the lows we've just hit?"

Regardless of what you think will happen, the market is quickly making up its mind without you.

As we speak, the market is busy adjusting to a mixture of positive and unexpected economic news. It doesn't care that the fundamental elements that drove us to economic disaster (excessive leverage at all tiers of American society) haven't significantly changed. It doesn't care that we don't really know what the actual consequences of the stimulus package will be. 

And either way, it doesn't matter. The market will always just constantly react, and that is what's important. From what it's telling us today, it's clear that the market is feeling optimistic. The bull is back.

Right?

Who knows?
The truth is that there's no real way to predict what's going to happen from here -- despite the grand certainty embedded in all of that "intelligent" analysis you'll hear on the news.

Talk to a member of the Austrian school, and he's probably loading up on food, gold funds like SPDR's Gold Shares, and ammunition right now. Discuss the subject with a Keynesian economist, and you'll likely walk away with a smile on your face. Talk to any reasonably knowledgeable individual on the subject and they probably have a few good reasons why their thinking is the right thinking.

But who really knows?

This combination of events and conditions is entirely unprecedented -- which means no amount of historical analysis will provide an answer with certainty. Experts on the Great Depression may know how to solve the problems of the Great Depression, but this isn't the Great Depression.

And thus, whatever happens in the market (like this recent bump), should be taken with a serious grain of salt. No one really knows what is going to happen.

So, what do we know?
What we do know is that by all reasonable measures, the market continues to be cheap right now. It's so cheap that businesses of all types (including very high-quality ones) are selling at once-in-a-generation prices.

Even though I'm not particularly confident in the recovery procedures our government is touting these days, I think the odds of success in the stock market going forward are strongly in our favor.

Companies like Altria (NYSE: MO  ) , Yum! Brands (NYSE: YUM  ) , and Pfizer (NYSE: PFE  ) -- high-quality businesses all -- are selling for so cheap that you should seriously consider buying. Truth be told, I'm eyeballing all three.

And they aren't the only ones:

Company

P/E

5-Year Average P/E

Transocean (NYSE: RIG  )

6.1

31.1

McDonald's (NYSE: MCD  )

15.6

20.2

Amgen (Nasdaq: AMGN  )

12.9

24.2

Halliburton (NYSE: HAL  )

11.8

19.1

Data from Morningstar. P/E = price-to-earnings ratio.

There is too much quality here, trading for too little, for you to stay out of the market.

Mr. Jeremy "Wizard of Wharton" Siegel apparently agrees, saying in a recent interview: "You are now investing when stocks are down 50% from their peak. ... Once you're down 50% from the peak there are almost no bad outcomes going ahead 10 years."

Now, I wouldn't go as far as saying that there's no chance of a bad outcome. (Remember, we've never been in this situation before!) But the odds of a good outcome are significantly higher than they were, say, 20 months ago.

The odds are with you
Back in the days when stocks actually went up over a considerable period of time, there was a lot of real risk plugged into the market. Growth assumptions were too generous, prices were too high, and -- most important -- very few people knew about the dangers of what was happening in the real estate and financial industries.

But since then, the market has been sliced in half, assumptions have been reduced, book values have been adjusted and a lot of scary information has been brought to light. Whether there's more bad news to come is unclear (credit cards? commercial real estate?), but though it may seem scarier to invest today than it did in 2006 (thanks to a media with a penchant for the sensational), mathematically speaking, it's simply not.

The Foolish bottom line
What we need to do here is simple.

There may be more bad news left to come, so hedge your bets. Concentrate on the companies that are historically very cheap, but still provide sufficient downside protection, in case we're all way off base.

That means pursuing companies with strong balance sheets, good cash reserves, and products and services that are not likely to go away tomorrow. You can have the best of both worlds that way.

If you like the idea of having bets stacked in your favor (plenty of upside, limited downside), then it's in your interest to find the types of companies I mentioned above. Where can you find them? The Motley Fool's Inside Value service is one spot: Advisor Philip Durell has identified 10 Best Buy Now stocks that are ripe for the picking.

Click here to take a free trial to the service today -- and enjoy all 70-plus recommendations and the top 10 picks immediately.

Already subscribed to Inside Value? Log in at the top of this page.

This article was originally published March 26, 2009. It has been updated.

Fool Nick Kapur is an Austro-Keynesian economist and owns shares of many top-quality companies. He currently has an active position in an inverse S&P 500 ETF for hedging purposes. Pfizer is a Motley Fool Inside Value recommendation. The Fool has a disclosure policy.


Read/Post Comments (2) | Recommend This Article (15)

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  • Report this Comment On June 03, 2009, at 12:00 PM, jkipling wrote:

    Wow! This is one of the most rational, pragmatic and sober analysis I've read in a long time. This puts pundits and columnists to shame! Everything, that is except the stock picks and Inside Value plug. But after all it is the Motley Fool, and that's what you do.

    Readers should look at it as your payment for the excellent content! And readers should also recognize the general point of the stock picks rather than focus on the picks themselves. Pepsi could just as easily have been included.

  • Report this Comment On June 03, 2009, at 12:25 PM, kurtdabear wrote:

    Aside from the fact that average PE's have been at historic highs for many years, PE's also are lagging indicators. In the current economic environment, investors should think twice about buying any stock right now, especially one with a PE higher than single digits.

    PE's have fallen because stock prices have fallen, even for companies that have been able to maintain their earnings levels; and stocks of companies that can't maintain existing profit levels have fallen further and will fall further still. The fact that a stock once traded at a particularly high PE does not necessarily mean that it will ever trade that richly again. ("Help! I've fallen, and I can't get up," comes to mind.)

    The stories you hear about trillions of $$ on the sidelines waiting to get back into the market are dubious at best considering all the trillions of $$ that U.S. families have lost in the value of their homes and retirement accounts in the past few years.

    With a new wave of housing foreclosures now starting, compounded by soaring credit-card delinquencies and a collapse of the commercial real estate market, it's a scary time to be too long.

    As distressed families look for money to save their houses and their cars, they'll borrow against their 401-K's or liquidate IRA's. That will not only decrease money flows into mutual funds but also create forced selling of securities that funds already own, thus driving stocks down even further than you might expect just from the effects of the general economic downturn.

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