By DAVID MOON, Moon Capital Management, LLC
October 14, 2012
A little more than 70 years ago, on October 1, 1942, the headline of the New York Times reported Nazi tanks pushing into Stalingrad and Adolph Hitler’s promise to take the Russian city.
This was less than ten months following the Japanese attack on Pearl Harbor and the US entry into a war in which more than 400,000 American would ultimately die.
The US annual deficit was 30.3 percent of GDP, more than four times today’s levels. The accumulated debt was headed to 121 percent of GDP, compared to today’s 100 percent debt-to-GDP ratio.
And after suffering from two massive drops in the previous 13 years, the US stock market was still 70 percent below its 1929 pre-Depression highs.
It is difficult to imagine a more angst-ridden time than 1942, especially for investors.
Although not quite as bad, 1982 came close to rivaling the decade or so following the Great Depression. Vietnam, Watergate, the Cold War and a string of assassinations, combined with 16 years of zero returns in the stock market, drove another generation of investors away from equities.
And just like 1942, both panic and opportunity set in about the same time.
In 1942 the stock market was about to begin a two-decade, 250 percent increase that ended with a market peak in 1966.
The 1982 bottom precipitated another 250 percent increase that ended with the collapse of 2000-2002.
Was there anything consistent or telling about the market bottoms in 1942 and 1982?
And perhaps just as importantly, was there anything in common about the market peaks in 1929, 1966 and 2000?
Yes, and it wasn’t politics, wars, taxes or even where the economy was in the business cycle.
At the three market tops, 1929, 1966 and 2000, the price-to-earnings ratio of the S&P 500 was 21, 20 and 30 respectively.
At the two market bottoms (1942 and 1982) the P/E ratio was 7.8 and 7.7.
In 2008, the most recent market bottom, the P/E of the S&P 500 was 8.1.
Writers and analysts today speak of losing an entire generation of investors, much like in the 1940s and 1980s. It is when those investors leave, however, that great bargains are left behind.
It is called capitulation.
If an improvement in investor confidence is preventing you from putting money in stocks, you are destined to make poor investment decisions. In the past four years investor confidence hasn’t improved a lick, yet the Dow Jones Industrial Average has doubled.
By the time investors decide things have gotten better, they often aren’t any more.
There is nothing magical about a P/E of 20 or 8, although all else being equal it is certainly a lot better to pay $8 for one dollar of earnings than it is to pay $20 for the same dollar of earnings. At market tops and bottoms people become fixated on the wrong things. They worry about elections and history and nuclear war with the Russians, Cubans or Martians – any of which would be a horrible thing.
But the most important thing from a financial perspective is the price of the investment.
David Moon is president of Moon Capital Management, a
Knoxville-based investment management firm. This article
originally appeared in the News Sentinel (Knoxville, TN).