How a 10% Pullback Just Made Stocks 20% Cheaper...
After two years of seemingly never-ending advances — with very few shallow pullbacks — the market has entered correction territory in record time.
It reminds me of a quote from investing legend Warren Buffett:
“For you see, Mr. Market is emotionally unstable. Some days he is cheerful and enormously optimistic… At other times, Mr. Market is discouraged and terribly pessimistic…”
If Buffett’s analogy for the stock market rings true, this is definitely one of those times when the market is “discouraged and terribly pessimistic.”
But ironically, that’s good news for you today. In fact, the news is even better than you may realize!
Coping With the Market’s Emotional Swings
New investors may be unfamiliar with the idea of the market pulling back sharply over a week or two.
But if you’ve been tracking your investments for more than just the last decade, you know that when the market corrects, it’s actually a great time to take advantage of “discouraged and terribly pessimistic” traders.
All you have to do is buy shares when the market is discouraged and sell them for a profit when the market becomes cheerful again.
Obviously, easier said than done.
But after this month’s pullback, you’ve got an extra reason to buy stocks that are currently on sale. You see, not only are stocks cheaper after the market’s pullback, but they’re also more valuable!
It’s not often that investors get this kind of opportunity. Usually, when stocks are pulling back by a significant amount, it’s because investors are worried about lower profits and a shrinking economy.
That’s not what is happening in today’s market.
Instead, investors started selling out of concern of rising inflation. And then as we discussed last week, the financial “weapons of mass destruction” kicked in, triggering a domino effect of selling.
But the falling stock market is actually very disconnected from the overall picture for the economy and for individual companies.
As companies report fourth quarter earnings for 2017, and management teams release guidance, expectations for profits this year keep climbing higher.
Which means the true underlying value for the stocks is increasing — at the same time the stock prices are decreasing. So as an investor, you’re getting much more for your money if you buy shares of quality companies right now.
A Double Value Investment Meal
Remember those “double value deals” McDonald’s used to offer? Well, today, the market is making a similar deal with investors, offering twice the value you might expect from this kind of pullback.
Here’s the data…
According to Bloomberg data, the amount of extra value you’re getting when you buy stocks today far exceeds the value you were getting just two weeks ago. And this value can be scientifically measured using a key statistic that professional investors follow.
The price / earnings ratio — or PE ratio — is simply a measure of how much investors have to pay for every dollar of earnings a company is expected to generate. A high PE means stocks are expensive, and a low PE means stocks are cheap.
Before the market correction, the average PE for the S&P 500 index was just over 20. That means you had to pay $20 for every dollar of earnings a company was expected to earn.
Now the market pulled back by roughly 10%. So it’s natural to assume that the average stock’s PE dropped by about the same amount.
But don’t forget about the higher earnings expectations!
You see, at the same time stock prices were dropping, earnings expectations were increasing. That’s because of the strong economy, tax cuts and other factors that are boosting 2018 profits for U.S. companies.
With earnings expectations growing, and stock prices falling, both sides of the PE equation have been quickly moving in our favor.
And so, at the end of last week, the market’s PE — or the cost that you have to pay for every dollar of expected earnings — dropped from above 20 to below 16.
In other words, you’re now getting a 20% discount on stocks. Nearly twice the discount you may have thought when you looked at the market’s pullback.
In short, this is a great time to be picking up shares of quality companies with growing earnings and cheap stocks. I can’t promise that stocks will immediately move higher from here. But I can tell you you’re getting a terrific value at today’s prices.
Now, let’s switch gears and take a look at the 5 things you need to know this week…
5 Must Knows For Monday, Feb. 12
Trumpfrastructure Announcement — Today, Monday, Feb. 12, President Trump is expected to release details on his spending plan. “Trumpfrastructure,” as we’re calling it, will include Trump’s plan for rebuilding America’s highways, bridges and water systems while also announcing his goals for the southern border wall. As of now, the plan is expected to be largely funded by state and local governments.
Kim Jong-Un Isn’t Fooling Anyone — Over the weekend, Kim Jong-Un continued to appease the South as he invited South Korean President Moon Jae-in to Pyongyang. This comes at a particularly suspicious time as U.N. sanctions have cut off major sources of revenue from the North. In addition, North Korea is reportedly in the late stages of developing a viable nuclear weapon, which leads some experts to believe North Korea is just buying time. If Moon Jae-in accepts the North’s offer, this will be the first meeting between Korean leaders in 11 years.
Crypto Regulation Fears Subside — After falling below $7,000 last week, the price of Bitcoin is now just under $9,000 as fears over government regulations are subsiding. This comes after U.S. regulators testified in front of Congress last week and suggested greater oversight without industry killing laws.
Earnings Season Rolls On — It’s still earnings season and this week has some great dividend-paying companies scheduled to report. On Tuesday, PepsiCo, MetLife and Western Union report. On Wednesday, Cisco, Marriott and Applied Materials report. And later in the week, Waste Management, Coca-Cola, John Deere and Kraft Heinz are all scheduled to announce earnings.
This Week in Economics — On Wednesday, the U.S. Labor Department releases consumer price index data for January. This comes on the heels of a January jobs report that showed wages grew at the fastest rate since 2011, which triggered the inflation fears that started last week’s volatility. And on Friday, the University of Michigan releases its consumer sentiment report. Economists are looking for increased optimism after American paychecks are finally seeing the benefits of Trump’s tax plan.
Here’s to growing and protecting your wealth!