Sunday, October 4, 2009

Is it time to invest in the stock market or stay on the sidelines?

From my CBC radio national column, September 24, 2009:

When G20 leaders meet in Pittsburgh today, they’ll be weighing whether or not to start scale back the stimulus packages that were announced after last year’s financial crash. But many experts are warning against throwing caution to the wind.
The advice could apply to individual investors as well as the world’s treasurers

With the stock markets performing so well recently, investors could be forgiven for thinking that good times are back. What are the people you pay attention to saying?

Here’s one person I pay attention to--David Rosenberg. He’s recently returned to Canada as chief economist and strategist at investment firm Gluskin Sheff after several years at Merrill Lynch in New York, where he was chief economist. Rosenberg was been credited with predicting the U.S. housing a time when many of his contemporaries were saying that the effects of the sub-prime crisis could be contained. At the time he was seen as being perhaps overly bearish, but events have vindicated him. .

So his forecasts command attention from the media and investors. And in the financial post this week, Rosenberg states that he thinks the market is overvalued

What’s his reasoning?

Equity prices are up something like 60 per cent from their lows in March, and that has Rosenberg concerned. He looks at something called the price-earnings ratio…this is something that looks at stock price and relates it to the amount of money companies are making. When you compare the prices some stocks are commanding right now to the amount companies are earning per share, he feels the increases just aren’t justified. In a recent note to clients, he’s quoted as saying that “there is too much growth and too much risk embedded in the equity market right now."

Markets generally increase (or decrease for that matter) for two reasons:

-The companies that make up the stock market are growing - people are buying their products/services or they’ve cut expenses.
-The second reason is that investors “think” the stock is a good deal. That’s when we get stocks increasing because of hype, fear and a bunch of other non-fundamental emotions.

When you look at the history of markets you realize that things don’t go up forever.
And so that’s why the cautions he raises make sense for me.

You really have to step back when you hear about double-digit gains and wonder if the time to get in is when everyone else is getting in or when everyone is getting out. That was the environment this spring. It’s quite the opposite now.

Any other insights from history?

This market, like many others, should be a reminder of the huge swings markets can take.

We just have to look back to the tech bubble which burst in the year 2000 and how many years of flat or negative numbers it took to finally get a profit on your investment. That market wasn’t even as bad as this one according to the experts and it still took a great deal of time to get your money back if you had invested right before the bubble burst.

Investors waiting on the sidelines might want to cool off and see this market for the erratic beast that it is. Just keep in mind that for most people a dollar lost is more important than two dollars earned.

And there’s one other historical event I want to remind everyone of….Any idea what happened 140 years ago today.?

Today is the 140th anniversary of the gold market crash of 1869, which led to a major stock market crash and became known as Black Friday.

The date is another good reminder of the boom-bust nature of markets, and the dangers of trying to chase big profits.

Unfortunately, when markets are exuberant, we as investors feel that they’ll be that way forever. On the flip side, when there’s nothing but bad news, like earlier this year, we think they’ll never go up. It’s a good reminder that investing in the stock market requires not only a strong stomach, but a great deal of caution.

Any final words of advice?

Yes, even the pro’s can’t successfully time the market. Just look at the poor performance of many mutual funds over the past year. So if they can't predict the markets, how can the average investor be expected to get it right?

Step back and keep in mind that a prudent, balanced approach to saving and investment is the best way to gain long term. That means looking beyond stocks. Adding other investments to your portfolio such as good old bonds, fixed income and even real estate are what you need if you're going to be able to weather financial storms in the long term.

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