A friend asked: What do you make of this rally? Is this May 2003 [beginning of four year cyclical bull market], or May 2008? [beginning of dramatic stock market declines]
Investors soon will realize that the growth prospects going forward are not 2003-2007-like. We are going through the consumer deleveraging that will depress the economic growth rate for quite awhile. I am not betting on much margin expansion for the corporate sector as a whole. Though cost cutting helps, sales growth is not there to exert economies of scale. Also, investors are still looking at past earnings as a guide for stocks’ earnings power. The cold shower of reality is that the past has passed and should force them to revalue their stocks.
Secular bull is out of the question as overall stocks are still too expensive, depending on what ‘E’ you use in the P/E. S&P 500 is around a P/E of 15-22 which is not cheap.
This is a stock picker’s market – owning stocks is not good enough, you need to own the right stocks – the ones that meet Quality, Value and Growth criteria (opens PDF). Though love of stocks is in the air, again, don’t fall in love with stocks. We are in the environment where being a buy and sell investor is paramount. It is important to sell the stock when it reaches its fair value level. Remember the ‘cyclical bull market giveth, the cyclical bear market taketh away’.
If you overpaid for a stock – in most cases that is because earnings power was overestimated or the margin of safety required was not high enough, or both. Don’t let anchoring drive your decision. ‘Anchoring’ is something that we all actively need to overcome (myself included), It is very natural but the very wrong thing to do. When we lose money on a stock we “anchor” (our sell price being based on what we paid for the stock), we feel the need to at least break even on our purchase as losses cause us pain. Thus we don’t want to sell the stock at any price below our purchase even if our research leads us to believe that the company is not worth the purchase price anymore. Forget what you paid for your stocks and revalue them again.
