No Place to Hide

Against all odds, international asset markets continue to climb higher. What can you do with your money these days? “Take your pick,” writes Dr. Steve Sjuggerud: “You can buy overpriced stocks, overpriced bonds, or overpriced real estate…”

[Ed note: Don’t miss the special report Steve helped to assemble – a massive 104-page guide boasting “everything you need to know” to invest in what may be the most profitable bull market of 2004, with contributions from Richard Russell, Jim Rogers, and your editor, Bill Bonner.

“Today we have substantially the worst prospects for long- term global investment returns of my 35-year career when all asset classes are considered, particularly for U.S.- centric investors. The asset classes collectively are simply the most overpriced they have been. There are no large categories that are good hiding places…”

– Wall Street Legend Jeremy Grantham, in his most recent report to his investors…

When it comes to investments today, there are very few places to hide. Nobody wants to hear negativity. But I don’t see this as negativity…I see it as reality. Back at the peak in 2000, there were still places to hide. For instance, to readers of my newsletter, True Wealth, I had recommended real estate and related stocks (REITs, homebuilders, etc.). We all know what real estate has done in the last four years. I’d also recommended several income ideas, which were once-in-a-generation opportunities, and they’ve performed even better than I could have imagined.

But now, in 2004, the pickin’s are slim…so slim that the most profitable investment approach now might simply be:

Ride the markets as long as they continue surging. But do so like someone who understands that they are overvalued – and that they will correct themselves.

P/E Ratios: A Choice of Overpriced Items

Let me explain. We’ve got interest rates at multi- generation lows, so you shouldn’t leave your money in the bank. Or should you? What else can you do with it? Take your pick: You can buy overpriced stocks, overpriced bonds, or overpriced real estate.

In times like these, Richard Russell (who’s been writing an investment newsletter for over 40 years) says, “He who loses the least, wins.”

In short, when you look around the world, there isn’t much value to be found in stocks. Let’s look at the U.S., and then we’ll look at the Hong Kong market, as a proxy for emerging markets and China.

The most basic valuation measure is the price-to-earnings ratio. It’s a rough gauge of how much you’re paying for an investment versus what you’re getting back in return. In simple terms, if you can earn $10,000 in rent on a house each year (net), and the price of that house is $150,000, then that house is selling for 15 times annual earnings. At 10 times earnings, or less, that house might be very cheap. At 20 times earnings, it’s probably very expensive.

The same is true for stocks. Throughout history, stocks have traded for roughly 15 times earnings. A stock market P/E ratio of 10 or less has proven to be cheap, and a great buy. Meanwhile, a P/E of 20 or higher has been an early warning sign of tough times ahead.

P/E Ratios: Us vs. Hong Kong

Let’s consider the P/E ratios of U.S. stocks and Hong Kong stocks in recent years: U.S. Stocks

P/E          Year

8              1982, a great time to have bought, in hindsight
22            1987, before The Crash, a good time to have sold, in hindsight
14            1990
32             March of 2000, a good time to have sold, in hindsight
28             Today

Hong Kong Stocks (notice how a similar picture to U.S. stocks emerges)

P/E            Year
6                1982, a great time to have bought
23              1987, before The Crash, a good time to have sold
10              1990
23              1993, China-related stocks crashed for 10 years 28 March of 2000, a good   time to have sold
19              Today

As you can see above, the P/E in the U.S. is 28 – nearly twice the historical average. That’s expensive. The downside risk may be greater than the upside potential over the coming years. Hong Kong is less expensive than the U.S., at a P/E of 18. But then again, emerging markets have traditionally traded more cheaply than their U.S. counterparts, as they are higher-risk investments.

It’s not just the U.S. and Hong Kong that are expensive. The entire world of stocks is expensive (with the exception of Russia – but the risk is so high, it may be appropriately priced. See for yourself at the end of this essay, where I’ve included P/E ratios of the world’s major stock indexes).

So 35-year investment legend Jeremy Grantham is probably right. Investments out there are expensive. This may indeed be the toughest environment to invest in during his 35-year career. There are few, if any, places to hide in stocks worldwide…be careful in stocks for the next few years.

“Only the huge, politically driven stimulus gives cause for hope, and that is for a short-term reprieve or rather a ‘stay of execution,'” Grantham concludes. Translation: Stocks, bonds and real estate could all push higher, as people look for a place to put their money.

But the real question is…where to go from there?


Steve Sjuggerud
for the Daily Reckoning
January 29, 2004

P.S. As promised, below are the P/E ratios of the major stock market indexes around the world (keep in mind that a P/E of 10 or less is considered a bargain)…

The Americas

28          S&P 500
126        Nasdaq
21          Canada
28          Brazil
16          Mexico


62          UK
21          France
61          Germany
44          Switzerland
27          Italy
19          Spain
20          Netherlands
32          Sweden
22          Finland

Emerging Europe / Africa

8            Russia
17          South Africa
21          Greece
31          Poland

Asia Pacific

111         Japan
20          Hong Kong
21          Australia
50          China (Shanghai)
41          China (Shenzhen)
44          Taiwan
18          India
23          Singapore
17          Malaysia
27          Thailand
17           Indonesia
23           New Zealand
24           Philippines

P.P.S. Fortunately, alternative investment opportunities outside stocks, bonds and real estate do exist. A prime example is gold – a classic ‘safe haven’ in times of uncertainty, but also a bargain at its current price.

Ride the markets if you can stomach the risk…but in the meantime, hedging your portfolio with an investment in gold is a wise move.

Editor’s note: Dr. Steve Sjuggerud has worked in the investment world as a stockbroker, the vice president of a $50 million global mutual fund, an international hedge fund manager, and the director of several research departments. Today, Dr. Sjuggerud runs his own 20,000-member investment advisory service called True Wealth. For more, see: True Wealth

A version of this essay first appeared in Dr. Sjuggerud’s biweekly free e-mail service, Investment University.

The Dow dropped 141 points yesterday. Is it the beginning of something big?

We don’t know. But surely investors must wonder…

Yes, stocks have gone up. “If you give me a trillion dollars, I can show you a good time, too,” said Warren Buffett.

Investors have had a very good time ever since the rally began in October 2002. Heavy partying has pushed the S&P 500 to trade at 28 times earnings.

But why does it make sense to buy at these prices?

“Because earnings are going up,” comes the answer…”And if earnings rise, so will share prices.”

But even if earnings DO rise as much as forecast – 13.5% in the year ahead – that leaves the average P/E still far below the long-term average of 12 to 16. Getting down to the average would require a 70% increase in earnings – which, of course, is not going to happen. And that’s merely to get to the average. Typically, following a bubble, P/Es fall to half the average. And they don’t sink down because the E’s (earnings) rise…they drop because the P (price) falls to a point where they are good buys again [don’t miss Dr. Steve Sjuggerud’s comments on the direction of P/E’s across the globe, below…].

The lumpeninvestoriat may not quite figure it out this way. Still, they must have a little nervous residue from the first leg down of the bear market, March 2000 to October 2002. They must remember that while they still believe in ‘buy and hold for the long run,’ those 18 months were a good time to neither buy nor hold. And if they were to sense a similar period coming up, they might well decide to ride it out by being neither buyers nor holders, but sellers of equities.

And whoa! Wouldn’t that be exciting? We might even see a day or two of utter panic selling on the Wall Street. Sooner or later, they will come, dear reader.

You might also anticipate a panic in the currency and bond markets. We don’t know if it will happen. But we don’t have to know. What we DO know is that the odds of these things coming to pass are almost certainly greater than most people think (since most people put the odds at zero)…and that you make money not by being right about the future but by being right about how your fellow investors have miscalculated in the present. A rout of the dollar? Collapse of the bond market? A new, more terrible bear market in stocks? Decline in house prices? Recession?

Recent surveys show neither economists, nor investment professionals, nor the lumps themselves can imagine such things. Which makes us think, not that they are necessarily imminent, but that we want to bet on them anyway.

Herewith, more news from Eric:


Eric Fry from the Isle of Manhattan…

– Yesterday, the pathetic U.S. dollar struggled through yet another trading day…until 2:15 Eastern Time. That’s when the Federal Reserve came to the dollar’s rescue by deleting two little words – “considerable period” – from the text of its Federal Open Market Committee statement.

– What is a “considerable period,” anyway?…Is it 15 minutes or 15 years? No one can say for certain. But yesterday, every investor in America seemed to know precisely what the ABSENCE of this phrase meant. Since August, the FOMC’s monthly statements have been promising to hold interest rates low “for a considerable period.” But yesterday’s statement replaced the longstanding phrase with a pledge to be “patient” in holding down interest rates. “With inflation quite low and resource use slack,” the statement read, “the committee believes that it can be patient in removing its policy accommodation.”

– Investors reacted swiftly and decisively to the semantic bombshell: the dollar soared, while stocks and bonds tumbled. (Gold, for its part, drifted lower). If the Fed will no longer promise to hold interest rates low for a considerable period, the lumpeninvestoriat reasoned, then surely the Fed is preparing to raise rates, which is good for the dollar but bad for stocks and bonds.

– By the end of the New York trading session, the dollar had rocketed one and a half percent to $124.70 per euro, while stocks FELL about one and a half percent. The Dow dropped 142 points to 10,468 and the Nasdaq stumbled nearly 2% to 2,077. Treasury prices also fell, pushing the yield on the 10-year note to 4.19% from 4.06% on Tuesday. Thus, the January stock market rally, which began amidst such fanfare and promise, is fading quickly as month end approaches. The Nasdaq still boasts a respectable 3.7% gain for the month, but the Dow is up a meager 15 points.

– The slumping stock market is irksome, but the drooping dollar is of far more concern. Despite the dollar’s one-day reprieve, the decrepit currency still faces the same daunting obstacles it faced before the Fed reworded its monthly statement. Like a potted palm on a Park Avenue terrace, the dollar battles each and every day to maintain its health.

– Never does our precious palm enjoy the warming sunshine of favorable macroeconomic trends. Instead, it finds itself in the frost of a widening current account deficit and a gaping federal deficit…The harsh U.S. macroeconomic environment is simply no place for a currency to thrive.

– Nevertheless, despite the adverse fundamental trends threatening the dollar, the hometown currency could still hold its value for a while, or even appreciate, as long as our foreign creditors maintain their hefty dollar purchases.

– “The United States long ago entered into an unholy partnership with its Asian creditors,” writes James Grant, editor of Grant’s Interest Rate Observer. “They would produce; we would consume. They would save; we would spend. They would invest – in us – buying Treasuries and agencies by the hundreds of billions of dollars worth. In effect [as we wish we had been the first to say], the United States and its lenders have entered into the biggest vendor- financing scheme in the history of lending and borrowing.”

– Then again, vendors expect to receive payment…eventually. If payment is not forthcoming, vendors withdraw financing and send the unpaid accounts receivable to a collection agency. Presumably, no one will ever threaten to break Uncle Sam’s knees if he doesn’t pay up by next Tuesday. But Uncle Sam and his currency could suffer a far worse fate if foreign central banks begin to withdraw some of their financing. Any significant retrenchment by our foreign creditors would be very bad news for the dollar…if that still matters to anyone. According to chairman Greenspan, the dollar’s exchange rate is no big deal, which is why the current account deficit is no big deal.

– “To date,” the increasingly wacky chairman said recently, “the widening to record levels of the U.S. ratio of current account deficit to GDP has been, with the exception of the dollar’s exchange rate, seemingly uneventful.”

– Hmmm…we would suppose, therefore, that the current account deficit will forever remain “uneventful,” as Greenspan would define, “eventful.” Certainly, if one ignores the dollar’s exchange rate, the current account deficit poses no problem whatsoever. In the same way, Greenspan might consider death to be “seemingly uneventful,” if we may ignore the fact that the deceased is no longer living.

– But we suspect that the dollar’s slide is eventful, especially when it is plummeting and the chairman of the Federal Reserve doesn’t care.

– Indeed, we think it is particularly eventful that the chairman of the Federal Reserve, whose principal statutory responsibility is to maintain the value of the dollar, considers the dollar’s steep slide to be “uneventful.” If the chairman of the Fed doesn’t care about the dollar’s value, who will?…Buyer beware.


Bill Bonner, back in Paris…

*** More on the stunning growth of the Far East, from our friend Martin Spring: “What are the factors which have already delivered astonishing economic development and suggest that there is much more to come?

* Liberalization of international trade and absence of major wars have provided a benign global environment, opening up the markets of the rest of the world to Asia’s new export industries.

* Asian governments and business leaders work closely together. There has been single-minded focus on promotion of production and wealth creation rather than on consumption, state welfare and redistribution of wealth.

* Taxes have been kept low, capital cheap and channeled into economic development. One of the secrets of China’s success is its creation of “export processing zones” where employers are largely free to pay and use labor however they wish. It’s a model that India now intends to follow with 20 such zones.

* Carefully managed mercantilism has provided cheap currencies, export incentives and protection for “infant” industries, but in combination with the controlled opening- up of domestic markets to imported goods, services and competition to spur continuous productivity improvement.

* Social attitudes favor the interests of the group (nation, corporation, family) above those of the individual.

* Quality mass education has been provided, with emphasis on the sciences.

* Savings ratios are very high (up to 50 per cent of incomes).

“The Far East has been the principal beneficiary of globalization, the process that has brought capital and technology to its enormous pool of inexpensive and highly productive labor, while allowing much of the resulting production to flow to the consumption-hungry nations of the rest of the world.

“This process is accelerating. Multinationals protecting their competitiveness and earnings are seeking to escape the high costs, burdensome taxes and over-regulation of the developed world by shifting their purchasing, production and administrative processes to cheap and efficient facilities in the developing economies, mainly in Asia.”

*** How do you like that, dear reader? We flatter ourselves, believing we have the freest, most dynamic economy in the world. Meanwhile, our businesses move to China and India – to get away from our high wage rates, union meddling, government interference, and taxes!

*** We are continuing our serious research of all things relating to what might be the world’s next economic superpower – India. Sitting across from us on the train last night was a woman who looked as though she might from India. We struck up a conversation.

It turned out that while her family was Indian by origin, she had been born in Hong Kong and worked as a financial analyst in London.

“It’s very funny, you know, having this background,” explained my lively and delightful traveling companion. “For while I live in the West and work with economists, brokers and analysts in the most sophisticated industry in the world…I still have these attitudes and ideas that come from my family background.

“We’re very superstitious…when my sister got married, for example, she had to clear it with the family priest back in Madras. Otherwise, it would be very bad luck. We believe in luck. If someone puts an ‘evil eye’ on you…you’ve got to get a priest to take it off. You’ve got to find some good karma to counteract the bad karma.

“India is booming. I know people who bought stock in some of the high tech companies in India that are doing very well… “

The Daily Reckoning