Getting Cheaper, But Still Not A Buy

By James J Puplava CFP, February 26, 2003

A common mantra on Wall Street and on the desk of financial anchors is stocks are cheap. It is time to start buying because we are in a new bull market. The major averages have now fallen three years in a row -- make that four, if you measure the markets this year. Markets have fallen four years in a row only once before and that was during the Great Depression. The feeling is that it can’thappen again. The safety net put in place during the Depression will prevent another depression from ever occurring. So why the worry? Instead, the Street believes that the markets hit their nadir last October and are now in the beginning stages of a new bull market. "Stocks are cheap" and �stocks are a screaming bargain� are echoed everywhere you look. It makes the headlines in papers, the front cover of financial magazines and on the cable channels, which in effect have become advertising billboards for Wall Street.

Fund managers are loading up their portfolios with bull market favorites on the belief that once the fireworks begin in Iraq, the markets are going to soar. This war, when it begins, will be telegraphed and made into a media extravaganza. Our bombers and fighter aircraft have been equipped with cameras so each bombing mission will be seen in real time. Those cameras will also protect the US against false accusations of strafing civilian targets or deliberately attacking civilians. In war, civilian casualties are hard to avoid, but if they occur the cameras will capture the pictures. There will be more than 500 reporters from around the world to write and televise it. It reminds me of gladiatorial events in the Roman coliseum. Welcome to warfare in the 21^st century. The high tech way in which this war will be fought, the bombing missions, the smart bombs, and technical wizardry of modern warfare is expected to generate large audiences for media companies. On Wall Street, they are hoping the high tech weapons will generate an investment gold rush with military technology generating the same Pavlovian response from investors as the tech revolution did. Networks will bilk the war for all that they can with 24-hour coverage and analysis provided by armchair pundits and would-be generals.

Once the war is over, oil prices will plunge, the markets will take off, and consumer and business confidence will be restored. It will be back to good times again. So on Wall Street, the feeling is let the war begin and let's remove all impediments to investing and the economy. Iraq, in the minds of analysts and money managers, is this year's excuse for falling stock prices. However, what happens if the war doesn't go as planned or if devastating terrorist attacks are carried out on US soil? What happens even if the war does go well and as a result, the US is faced with governing Iraq until a suitable government can take over the reins and restore order to the country? What will be the cost of this occupation? More importantly, what about the lives of some soldiers who will die in this conflict? On the other side, there will be sons and husbands who also lose their lives. War is never something to celebrate, much less turned into a media circus.

Regarding the investment markets, the war won't change the debt levels of this country; they will only make it worse. War isn't going to solve or pay for Herbie Homeowner and Larry Lawnmower credit card bills. It won't pay for underfunded pension plans or absorb the glut of tech capacity that still exists in this country and around the globe. Unless the Pentagon has plans to drop cell phones, DVD players, PC's, video games and PDA's on Iraq, there is a mountain of this stuff piling up in the warehouse and distribution channels around this country. The fundamentals of the tech industry are horrible and remain uncertain. Why else would tech CEO's keep firing so many workers?

Now as far as the reason to buy stocks because they are cheap, let us examine that picture. As shown in the three tables below, I have listed the top ten market cap stocks that make up all three major indexes in the US. Starting with the Dow and proceeding to the NASDAQ, one can draw several conclusions. Stocks have gotten cheaper from where they were three years ago, but they are far from being a bargain. You will notice that stock valuations become more expensive as you move from the Blue Chip Dow, the S&P 500, and the NASDAQ. The top ten companies in each index make up some of the finest companies within the US. They are all leaders in their field. They are, for the most part, great businesses and great business franchises. However, with the exception with one company in the Dow, they are hardly cheap. When stocks are selling at 2 to 3 times their growth rates, they are not cheap. They can only viewed as cheap if you use your wildest imagination, which is why Wall Street is often referred to as "The Street of Dreams."

Dow Jones Industrials
Company	P/E	Div %	P/Book	P/Sales	P/CF
3M	24	2.1%	8.1x	3.0x	17.3x
Procter & Gamble	21	2.0%	8.0x	2.6x	12.1x
IBM	20	0.8%	5.9x	1.6x	9.7x
United Technologies	13	1.7%	3.3x	1.0x	9.6x
Merck	15	0.9%	1.8x	0.1x	12.8x
Johnson & Johnson	23	1.6%	7.0x	4.2x	17.8x
Wal-Mart	26	0.6%	5.4x	0.9x	16.9x
Caterpillar	20	3.0%	2.9x	0.8x	8.5x
Coca Cola	22	2.2%	8.3x	5.0x	20.8x
Altria	8	6.7%	4.0x	1.3x	7.4x
S & P 500
Company	P/E	Div %	P/Book	P/Sales	P/CF
Microsoft	24	0.3%	4.5x	8.2x	15.4x
GE	15	3.3%	3.7x	1.8x	7.8x
Exxon-Mobile	20	2.7%	3.0x	1.2x	11.7x
Wal-Mart	26	0.6%	5.4x	0.9x	16.9x
Pfizer	18	2.0%	9.4x	5.2x	20.0x
Citigroup	12	2.5%	1.9x	1.8x	6.0x
Johnson & Johnson	23	1.6%	7.0x	4.2x	17.8x
IBM	20	0.8%	5.9x	1.6x	9.7x
Am. Int'l Group (AIG)	18	0.4%	2.2x	2.2x	11.3x
Merck	15	0.9%	1.8x	0.1x	12.8x
NASDAQ
Company	P/E	Div %	P/Book	P/Sales	P/CF*
Microsoft	24	0.3%	4.5x	8.2x	15.4x
Intel	32	0.5%	3.0x	4.0x	12.1x
Cisco	25	0.0%	3.4x	5.0x	17.5x
Dell	32	0.0%	13.6x	1.9x	19.5x
Oracle	29	0.0%	11.7x	6.6x	19.9x
Amgen	38	0.0%	3.8x	12.4x	29.1x
Fifth Third Corp	19	2.0%	3.6x	4.8x	21.0x
Qualcomm	29	0.6%	4.5x	7.7x	25.2x
Comcast	182	0.0%	1.7x	2.2x	12.3x
EBay	88	0.0%	6.7x	19.5x	46.4x
* P/CF = Price to Cash Flow

They only become cheap if you use historically low interest rates, which are used to discount future earnings. Even then P/E multiples of 20, 26, 32, 88, and 188 are not a bargain. Dividend yields of .3, .6, and 2% don't compensate in current return for many of today's stock market risks. Nor are companies whose stock price is 4, 8, or 12 times book value or 4, 6, 8, or 12 times sales. In summary, all we can say is that stocks have gotten cheaper than they were three years ago, but they are still far from being a bargain. At the bottom of bear markets you will find stocks selling at 5 to 7 times earnings. Dividend yields will be higher than Treasury bond yields and will be selling at less than book value and annual sales. By then your neighbors will have sold out their positions forswearing ever owning a stock or mutual fund in their lifetime. Speculating in stocks will cease to be a national pastime. Cable channels will go back to covering news and sports. People will go back to saving and consumption will be a luxury other than basic necessities. That is when you will know that the bear market has ended. That will be the time to buy with complete abandon. The only problem is that you would have had to conserve your capital and be in a position to buy.

Back to the day's horse trading, the markets headed south again for many of the same reasons given their climb yesterday. Instead of falling oil prices, we had rising oil prices. The price of crude oil hit a 12-year high. Intra-day prices got as high as $37.70 a barrel as a report was released that U.S. inventories fell 1 million barrels to 271.9 million in the week ending Feb. 21. Inventory levels have fallen 14% from a year ago and are now at a three-decade low. In the words of one trader, �Inventory levels are now dangerously low. We are only one small problem away from operating the nation's refineries at a minimum. If more supply is needed by the economy, refineries, consumers, and businesses are going to have to pay up.� The east and midwest portions of the country are still experiencing harsh weather, so demand for heating oil is drawing down inventories. There is no excess capacity available.

All Is Quiet On The Earnings Front

As far as the month is concerned, it looks like stock prices are headed down for their third straight month. The S&P 500 is down 3.3% this month and is down 5.9% for the year. The Dow lost 3.1% this month and is down 6.4% YTD. The NASDAQ is down 1.3% this month and 2.4% this year. The NASDAQ is the most overvalued market of all three major indexes. This is where the money is. This money is vulnerable to a huge setback if things don't play out as planned. Preliminary reports hint that Q1 of this year isn't going to be rosy. HP reported that their Q1 fell short on the revenue side as demand slowed as a result of companies pulling back on capex spending. Companies have been laying off more workers and energy prices and rising commodity and labor costs are zapping profit margins as there is little room to raise prices. Inventories are building and further stock market losses mean companies will have to contribute more money to fund company pension plans. Q1 is looking bad. Wall Street has got its work cut out for it. They are going to have to pull a rabbit out of the hat or turn investors' attention away from earnings. Maybe that is why they are looking at war. Energy prices have risen 42% in the last three months and gasoline prices are near or at records in certain parts of the country. Higher energy prices are an additional tax on the economy.

Volume hit 1.34 billion on the NYSE and 1.21 billion on the NASDAQ. Volume continues to decline in the market, which is not a good sign for the bulls. Breadth was negative by 19-12 on the Big Board and about the same on the NASDAQ. The VIX rose .90 to 37.02 and the VXN jumped 2.64 to 46.97.

Overseas Markets

European stocks fell as Swiss Reinsurance Co. became the region's latest insurer to say it will reduce its dividend and Aviva Plc, the U.K.'s biggest insurance company, said profit may decline this year if stocks drop further. The Dow Jones Stoxx 50 Index fell 1.1% to 2113.70, paced by Bayer AG as the drugmaker said it may put aside money to settle lawsuits over cholesterol treatment Baycol. The Stoxx 600 Index shed 0.9% to 177.40. Both indexes dropped for a fifth day in six.

Japan's Topix stock index fell for a seventh day, its longest losing streak in 20 months. Mizuho Holdings Inc. slid after saying it plans to sell $1 billion of preferred shares, which will dilute shareholders' returns. The Topix dropped 0.1% to 818.38, with Mizuho, the world's largest bank by assets, slumping to a six-week low. The Topix had its longest string of losses since the seven days ended June 19, 2001. The Nikkei 225 Stock Average was little changed, shedding 3.68 points to 8356.81.

Chart courtesy of www.stockcharts.com

James Puplava

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James J. Puplava CFP
PFS Group
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San Diego, CA 92150-3147
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