Investing–The New Rules: Stocks Are Not Worth Buying Today

Stocks not a good buy today

Are stocks worth buying today? Rob Bennett says, “No” as the short reply. His longer answer is in today’s Investing: The New Rules.

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Investing — The New Rules
Stocks Are Not Worth Buying Today

#9–June 28, 2010

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Are stocks worth buying today?

No.

That’s the short version of the answer. The longer (and thus more accurate) version follows below.

When stocks are selling at the price at which they are selling today, the most likely annualized 10-year return is a bit above 3 percent real. You should be compensated for taking on the risks associated with buying stocks. So my rule is that I will not buy stocks unless I am likely to obtain a long-term return of at least 2 percentage points better than what is available from the super-safe asset classes. Certificates of Deposit or IBonds paying a real return of better than 1 percent today offer a better long-term value proposition than stocks.

Moreover, the case for stocks today is worse than what you can learn from looking solely at the numbers.

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That 3 percent number is a ten-year number. There’s a big difference between earning a steady 3 percent return in every year for ten years running and losing 50 percent of your money over the course of several years before seeing a turnaround that gets you back to an annualized return of 3 percent real at the end of 10 years.

It is not possible to predict short-term developments. So I cannot say with certainty that we are going to see another stock crash in the next few years. However, I think it is fair to say that the odds are tilted far more in favor of a stock crash than they are in ordinary times.

We are today living through the aftermath of the fourth time in U.S. history when stock prices went to insanely dangerous levels. On the first three occasions, prices subsequently fell to one-half of fair value. Seeing that again would mean seeing a price drop of greater than 60 percent from today’s prices.

There’s no guaranty that history will repeat exactly. But there’s good reason for anticipating that it will at least rhyme. It’s not an accident that times of insanely high prices have always brought on times of insanely low prices. Insanely high prices cause millions to believe that they possess far more in the way of real wealth than what they really do possess. That belief causes millions of bad financial decisions; bull markets make people spend more than they can afford to spend. When people realize that they have been making poor financial decisions for years or for decades, they panic. Panic causes insanely low stock prices.

Things play out in the way they always have played out for a reason. We are not able to say with confidence how things are going to go over the next year or two or three or four. But I think it is fair to say that a big price drop is a far more likely scenario than a big price increase. So the downside potential for stocks is far greater than the upside potential.

The best bet is that we will see a return of something in the neighborhood of 3 percent real at the end of 10 years. But it bears keeping in mind that the journey stock investors will undergo in getting there is likely to be an extremely bumpy one. Is it worth it?

The other side of the story is that the best time to buy stocks is at times when we go to insanely low prices. When stocks are priced at one-half of fair value (as they were in 1982, the last time we were in the process of recovering from an out-of-control bull), the most likely annualized long-term return is 15 percent real. People worry that the returns paid by the super-safe asset classes is too low. But those returns don’t look so low anymore when you consider that any money not lost in the next crash will be available for investing in stocks at extremely appealing prices.

There’s one more factor that needs to be taken into consideration. How much did you lose in “The Lost Decade” (the years from January 2000 through today)?

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ALSO at DBKP:
* Investing–The New Rules: Sarah Palin Will End Economic Crisis
* Investing–The New Rules: Dollar-Cost Averaging is a Loser
* Investing–The New Rules: John Bogle’s Evil Twin?
* Investing–The New Rules: Stock Return Predictor Not a Case of ‘Too Good to be True’
* Investing–The New Rules: The Stock Investor’s Weather Report
* Investing–The New Rules: Harness the Power of The Stock Return Predictor
* Investing–The New Rules: Get the Odds on Your Side
* Stock Investing: Much of Today’s Understanding is Primitive

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The one good thing that can be said about stock prices today is that they are better than what was available at any time from January 1996 through 2008. If you were going with a zero stock allocation for that entire time-period, it makes sense to move up to a stock allocation of 20 percent or 30 percent today. The value proposition is not yet good. But it is gradually improving.

Most are not in that situation. Money invested in stocks has been dead money for a long, long time. Those who become serious savers at age 35 only have three decades to accumulate the money they need to retire on by age 65 and those who were invested in stocks during the insane years have nothing to show for one of those three decades.

Those of us who have suffered that serious a hit are in no position to be taking on unnecessary risk today. And yet risk is high in this asset class at today’s prices (the crash only took prices down from the “insanely risky” levels to the “dangerously risky” levels). Stock prices are good today only in comparison to how awful they were for a long, long time before the crash.

I don’t want you to wait until stock prices have fallen to one-half fair value before investing heavily in stocks. It’s not possible to predict stock prices with precision. So getting too cute with your moves into and out of stocks is foolish.

But prices are just too high today. There will be a time when stocks will be worth investing in again. And that time may not be all that far off in the distance anymore. But it’s not here yet. Today is a time for continued patience mixed with some anticipation of the day when stocks will become an appealing long-term investment class again.

by Rob Bennett
images: DBKP file

Rob’s interview with ABC News is here. His bio is here. And please don’t even think of failing to read these Important Cautionary Words.

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