September 26, 2004


A Huge Opportunity Is Brewing (Donald Luskin, September 24, 2004, Smart Money)

THERE HAS BEEN a stock-market crash this year. You didn't know that? That's because it's invisible.

Think about this: So far in 2004, earnings for the S&P 500 have grown by 19%. Yet as of Thursday's close, the S&P 500 is virtually unchanged, having fallen by 1/3 of one percent before considering dividends.

With earnings up by that astonishing amount in just nine months, and the market unchanged — that's a crash. But it's not a crash you can measure in prices. It's a crash you have to measure in value. That's why it's invisible. But it's still very real.

All else equal, with earnings up 19%, the market should also be up by 19%. In fact, I think the market should be up even more than that, because at year-end 2003, stocks were already cheap.

Put it all together, and stocks are so cheap now that my valuation model says that the S&P 500 could rise by almost 35% from here and still be only fairly valued. [...]

I don't know exactly what the news catalyst will be to send the market higher. Maybe the oil price will drop dramatically — either falling of its own weight (because there's really no reason for it to be this high in the first place), or perhaps because of the Bush administration's decision to tap the nations' Strategic Petroleum Reserve (which the Clinton administration did before the 2000 election).

Or maybe a clear victor will emerge in the first presidential debate, now scheduled for Sept. 30. The strong lead that George Bush has established in the polls already should be a major boost for the market, because it goes a long way to eliminating the enormous uncertainty of which of two very different economic visions will guide the country for the next four years. If Bush emerges victorious in the first debate, it will make him unbeatable in November — and the last of the electoral uncertainty restraining stock prices will be gone.

At the moment, it truly is still an uncertainty.

That's the great mystery dragging on the economy. If 9-11 was, for good reason, enough to create this mood of uncertainty, what can break it? What would a positive equivalent to 9-11 look like? Would an election landslide suffice?

Posted by Orrin Judd at September 26, 2004 7:16 AM

I suspect investors still do not trust the number crunchers. It is a hard thing to regain trust and respect. People remain convinced that it is too easy to game the system.

Posted by: Pilgrim at September 26, 2004 9:37 AM

What would a positive equivalent to 9-11 look like?

Osama .... on a stick.

Posted by: Chris B at September 26, 2004 9:51 AM

The invisible hand writes: and, having writ, moves on.

Posted by: Adam Khayyam at September 26, 2004 5:31 PM

How much of a "number cruncher" does one have to be to suspect that a company that's never turned a profit and is burning through cash at the rate of tens of millions per quarter probably isn't worth $ 10 billion ?!?

Posted by: Michael Herdegen at September 27, 2004 4:08 AM

I think "market valuation" is simply not a
trusted maeasure of economic activity at this
point. That's why IPO's slowed down to a trickle
and it's why dividends have increased slightly.

We should accept that we live in a world
with multi-polar and independent economic indicators that often conflict. Uncertainty
in this case is not necessarily the same
as a foreboding.

Posted by: J.H. at September 27, 2004 9:50 AM

The stock market is a leading indicator. The 19% rise in profits was anticipated by the rise in the market from Oct 2002 to Dec 2003.

The market is overvalued, not undervalued. This guy is sniffing glue. Profits will be harder to come by going forward. Commodities, raw materials and energy are getting more expensive, but companies cannot raise the prices on their finished goods, so the bottom line will suffer. The consumer is tapped out. Government stimulus is tapped out. Where will the growth come from?

Posted by: Robert Duquette at September 27, 2004 11:22 AM

It's historically undervalued if you look at p/e.

Posted by: oj at September 27, 2004 11:45 AM

Look at GAAP P/E, not Pro-forma.

Posted by: Robert Duquette at September 27, 2004 3:30 PM

Trust the market and get screwed.

Posted by: Harry Eagar at September 28, 2004 1:11 AM

Geez, Harry, we tried your way and it didn't work. Marxism is a dead letter.

Posted by: oj at September 28, 2004 7:25 AM

I at least believe in the market, even if I don't admire everything you get with it.

You guys don't really even believe in it.

How can a market be undervalued or overvalued? What are you measuring it against?

Posted by: Harry Eagar at September 28, 2004 2:22 PM

History. We don't believe markets are ever right, just that they work over time. The genius of the market is that other folks are just waiting to punish bad decisions, unlike a top down system, which you prefer, where the bad decisions keep piling up without any corrective.

Posted by: oj at September 28, 2004 4:04 PM

'Work' is the defining term.

I can name you a hundred places where the markets were free, but you'd hardly agree that they 'worked.'

Posted by: Harry Eagar at September 29, 2004 5:56 PM


Yes, the market is secondary--a great legal system and a society built on trust come first. Both are rare. The latter requires Judeo-Christianity so is especially rare.

Posted by: oj at September 29, 2004 6:41 PM