Tuesday, April 15, 2014

US Stocks Are 50% Overvalued … It’s Time to Get Out

by Bill Bonner

Buy Them When They're Cheap

The Dow fell 143 points on Friday. Gold was just about flat. Why the fall in stock prices? Many reasons were proposed, but no one knows for sure. There may not be a reason at all. Stocks don’t need a reason to fall. From time to time, they just do. Not to put too fine a point on it, but asset prices go up … and then they go down. Always have. Always will.

Generally, it’s a credit expansion that drives them up. A credit contraction takes them back down. Credit is still expanding, says economist and author of The New Depression: The Breakdown of the Paper Money Economy Richard Duncan. But come the next quarter, watch out. Duncan reckons “excess liquidity” (as he calculates it, the surplus left over between QE stimulus and what the federal government absorbs through borrowing) is going to contract – sharply.

It hardly matters to us anyway. We buy stocks when they are cheap, not expensive, relative to their historic average. And on a CAPE (Cyclically Adjusted PE Ratio) of 24.7, the S&P 500 now trades at a 50% premium to its historic average CAPE of 16.5. My advice: Get out. And stay out, until the index is cheap again.

Thin Margins

Last week, we mentioned how life on the ranch here in northwestern Argentina toughens you up. Physically … and otherwise. Our business career, for example, has been soft and charmed. In the publishing industry – the only one we really know – cleverness is rewarded. Good ideas and hard work pay off.

But here it doesn’t matter how clever you are … or how hard you work. Margins are as thin as the desert air. Profits are as scarce as the grass. When a man reaches a certain age, he is ready for a new challenge. His career winds down … or comes to an abrupt halt. He needs something to occupy his time and his remaining energy.

His wife is usually fully behind him. The last thing she wants is an idle husband left with nothing to do; he might decide to reorganize the kitchen! Some turn to golf. Some turn to new businesses. At least one bought a cattle ranch in South America, which turned out to be a good place to grow high altitude Malbec grapes.

We spent all of Thursday and most of Friday cosechando (harvesting). We shuffled along the rocky soil on our hands and knees reaching up to cut off bunches of grapes … tossing them into a plastic bin … and then scraping along to the next vine. This went on long enough to convince us that we weren’t cut out for this kind of work. Our knees hurt. Our back and legs ached. Our shoulders were sore.

It really didn’t suit any of the “old guys” helping with the harvest. Nolberto’s body is twisted from a lifetime of hard work. He is one year younger than we are … but has suffered a lot more wear and tear. Jorge is two years younger. He complains of arthritis in his shoulders and arms. Natalio is seven years younger. He has no complaints. But he moves more slowly than the younger men.

Older and Wiser?

An older investor is perhaps a better investor – if he is still solvent. He is a survivor. He is wiser for it. He has seen more scams, crackpot theories and pie-in-the-sky business plans than a younger man. But age is no advantage to the cosechero (harvester) – even one who has been toughened up by life on an Andes ranch.

In business, too, age can be an advantage. An older man is more suspicious and more cynical. He expects trouble and setbacks. He is rarely disappointed.

He is also wary of business plans. Especially his own. But people run businesses for a variety of reasons – not only to maximize earnings … and rarely to maximize shareholder value. Many businesses are run for pleasure, self-aggrandizement, vanity, spite or just cussedness.

Art galleries, boat charters, yoga studios, airlines, fancy rental properties – and vineyards – rarely make money. At least, in our experience. Most often, they are things that people want to do … and justify it with a hope. Paris pied-à-terre apartments – for example – are bought because people think it would be cool to have their own place in the City of Light. Then they set it up as a rental, telling themselves that the place “will pay for itself.” Sometimes it does.

Likewise, an art gallery is often a vanity project. An art lover feels he should inflict his tastes on the community. So he sets up a gallery where everyone who walks by will see what he considers decent, or perhaps provocative, artwork. He convinces himself the project will “at least break even on operating costs.” Perhaps it does – sometimes.

As a general rule, the more attractive a business – socially, artistically, environmentally or ethically – the more money it will lose. Nobody brags to his friends about his used auto-parts business … or his ghetto payday loans or his 24/7 liquor outlet. Nobody enters these businesses, except for the money. And the money tends to be good.

The money from an Argentine ranch run by a North American rogue economist? Bad.

Details to follow when we next convene … which may not be tomorrow. Another aspect of life here at the ranch is the reliability, or lack thereof, of our Internet signal, which comes by way of satellite. I apologize in advance for any further outages, which are a common enough occurrence these days.

S&P composite price and CAPE (Shiller P/E or Cyclically Adjusted Price Earnings Ratio), via Doug Short /Advisor Perspectives. Cheap is something else – click to enlarge.

The above article is from Diary of a Rogue Economist originally written for Bonner & Partners. Bill Bonner founded Agora, Inc in 1978. It has since grown into one of the largest independent newsletter publishing companies in the world. He has also written three New York Times bestselling books, Financial Reckoning Day, Empire of Debt and Mobs, Messiahs and Markets.

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