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Struggling Stocks, Booming Commodities
04/28/2005
The NASDAQ has fallen -12.5% since the start of 2005. S&P500 Index
suffered -5.7% this year. The US stock market has been terrible
over the past few months.
Not only is the general market down, but oil stocks have recently
important fix as well. It’s easy to be nervous
because of the short-term setback. However, to succeed
with long-term value investing, we can’t be distracted
by the volatile movement of the short-term market. It’s time to
take a step back and look at the big picture of current stock
market and review the investment strategy to take advantage of this type
difficult environment.
Inventories in general and oil stocks
The chart below is the 1 year performance chart between Energy
ETF index (ticker: XLE) and S&P500 index (ticker: SPY). By
looking at the chart, even a fool will know that the oil market
is booming while the US stock market in general is struggling.
Put simply, the current US stock market is not up
market. The heyday of the 1980s and 1990s where anyone can
just put money in an S&P500 index fund or a decent US fund
mutual fund to earn 10% to 20% more annual performance is
long gone. I expect for the next 8-10 years the US stock
market in general will stagnate.
If you believed that 20 years of scholarship
the performance between 1980 and 2000 is the stock market average
performance, then you will be shocked to know that just
before this period in the 1960s and 1970s, the US stock market
went nowhere. The Dow reached 995.15 in 1966 and the Dow returned to 800
in 1982. If you were the long-term investor who invested in
Dow index fund between 1966 and 1982, you have a negative -20%
overall return for your 16 years of loyalty, how would you
feel that?
Do you still remember the NASDAQ peak of 5000? In my opinion,
The NASDAQ is a screwed up index with lots of expensive stocks
even today. I predict we may have to wait for another
decade to revisit the NASDAQ 5000.
The current average stock market valuation is not cheap
Currently, the SP&500 index is trading at around 17 times the average PE today.
Although this assessment is not very expensive, it is not
that cheap either.
Over the past 100 years of US stock market history, the market
usually reaches an average PE of 10. This happened in 1974
or 1929 or 1980. We’re not there yet, not even close
Last 5 years even though the tech stock bubble burst
in 2000. In a major stock market trough, we should see
many large-cap stablecoins are trading at a low PE
teens. Now watch this: Coca-Cola (KO) PE 20, Walt Disney
(DIS) PE 24. Even worse, a stock without growth like Sun
Microsystems (SUNW) is still trading at a premium PE of 19.
What is the overall outlook for US stock market gains?
Even if the current market valuation is not so
cheap, if revenues are good, the market should do well.
Are we going to get great overall revenue prospects in the
coming years for the US stock market in general?
Unfortunately, my answer is no. My view is that US stocks
overall, market earnings are okay, but not good enough to
trigger a bull market. This market is still digesting
past bubble overvaluation coupled with low incomes
prospects.
Here’s one of the reasons for my not-so-enthusiastic winning
outlook: rising oil and commodity prices.
The booming price of raw materials
The commodity and oil market has been booming since 1999 and
high commodity prices weigh on the entire stock market
earnings. Companies have to pay more for necessary things
in business: steel, copper, oil, natural gas, etc.
Historically, when the commodity market shone, the stock market
didn’t do very well, and vice versa. In the 1960s and 1970s,
oil and commodities have been in a bull market for almost 20 years
while the Dow Jones index has performed horribly for almost 20 years. Of
From 1980 to 2000, the stock market soared as oil bottomed out
like $15.
The bull cycle for oil and commodities could be very long
Jimmy Rogers is a famous investor who co-founded Quantum Fund
with George Soros. In his recent book entitled “Hot
raw materials”, he predicts that the current raw material
bull market may last until 2013 strictly due to supply and
request.
In a chapter of the book entitled “Goodbye, Cheap Oil”, he
clearly spells out the reasons why oil and natural gas are bullish
market may last for the next decade. It’s as easy as
supply and demand: increase in demand coupled with a decrease
supply.
The supply of oil and natural gas has declined in part due
Extremely low oil and gas prices in the 1990s. Over the past 35
years, there has been no major discovery of oil in the world while
old oil fields are running out. Oil and natural gas production
the level of a well does not remain flat for the life of a well
Reserve. The production level of a well actually decreases
gradually due to the geophysics of the oil well until the reserve is
completely exhausted. Even if there is a new oil deposit discovered, it
will take a decade after discovery to actually produce
oil! Increasing supply to meet demand is a very difficult task
and slow process.
Combined with the drop in supply, the demand for energy from
China has doubled since 1990 by consuming 8% of the world’s oil
in 2004. The US economy is growing with increasing demand for oil
from one year to the next while American oil production experienced a strong
decline over the past 50 years.
Yet the price of oil is not that high on a historical basis.
Even with the current oil price of $50 a barrel, the price of oil
is still well below inflation-adjusted
record price of $90 a barrel in the 1970s.
Value investors don’t need a bull market to make money
As frightening as potential stock market problems, this kind
of a difficult environment is an excellent time to earn money
investors to buy cheap stocks.
Warren Buffet is the world’s greatest value investor.
It has averaged 20% annual investment returns over the past 50
years. However, Mr. Buffet’s performance in the bear market of
1960s and 1970s was actually 30% return per year, a lot
above its average performance.
Focus on very cheap stocks and the booming commodity market
Stocks do not go up or down directly. There will be
be a huge surge or a short-term hard sell. While the market
is out of shape, it is and will be a wonderful time for
long-term value investors.
Commodity prices are volatile. Just like the stock market,
the price of raw materials does not go up or down directly.
Although the price of oil has weakened recently, I firmly believe that
the price of oil does not return to a cheap oil price below $40 per
barrel. As long as oil and natural gas prices remain high, oil
stocks will do well. As painful as
recent strong sell-off in energy stocks, energy stocks in
general are still very cheap and my investment strategy is
continue to remain long-term oriented in them.
In the short term, it is very difficult to know when an action
up or down. But I know the evaluation and the gains
matters and invest in cheap stocks that trade significantly
below the market average will be rewarding in the long run.
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