Monday, May 10, 2010
The past two weeks have been a disaster for stocks.
The news everywhere is terrible. Goldman Sachs is committing fraud against Main Street. Some 5,000 barrels of oil are gushing into the Gulf of Mexico each day. People are dying in the streets of Athens... and Portugal and Spain may be next on the list to get bailed out.
At home, our deficits are spiraling out of control. President Obama is forecasting a record budget deficit of $1.6 trillion in 2010.
Then, last week, we had a complete breakdown of our financial system. Whatever caused it, the market lost $1 trillion of its value in 10 minutes before recouping some of its losses.
Now, the S&P is at two-month lows. Is it time for investors who are long stocks to panic?
I don't think so.
My fellow Growth Stock Wire editor Jeff Clark is worried about the bigger economic picture, and he's been cautious on stocks. I agree with him. I think we might see a further pullback in stocks.
That's why I suggested taking some cash off the table in Growth Stock Wire on April 29. I said, "Although earnings are strong, markets do not have a history of going up in a straight line. In other words, don't hesitate to take profits."
I think we have 5% more downside ahead. That would put the Dow Jones Index at about 10,000. The S&P 500 index would fall to 1,065. But I don't think we're headed for another crash. Here's why...
First, based on forward earnings, the S&P 500 Index is trading at its cheapest level in 20 years. The S&P 500 traded over 45 times earnings at the top of the Internet boom. Today, stocks are trading at 14 times forward earnings.
Second, companies are holding more cash than any time in the past 40 years. Back during the Internet boom, companies were spending exceptional amounts of cash to grow. Also, they had few hard assets. But today, the average S&P 500 company is holding more than 10% of its assets in cash.
Third, interest rates are zero. They will stay at record lows into 2012, according to some Fed officials. Low interest rates are like jet fuel for these companies. They can borrow for next to nothing to grow their business.
(If interest rates do stay low for another 18 months, it'll mean huge profits for the banking industry in particular. Just look at the surge in banks since the Federal Reserve eased rates. Today, Citigroup has a larger market cap than Intel and Hewlett-Packard. Wells Fargo, JPMorgan, and Bank of America have a combined market cap of more than a half trillion dollars.)
Finally, the stimulus plan: More than $500 billion of the stimulus plan has yet to be spent. Congress mandated that this money be spent by 2011. It will be used to increase lending to small businesses, restructure mortgages, and further extend unemployment benefits.
Bottom line: Growing earnings, liquid assets, low interest rates, and even more government stimulus will put the wind at the market's back.
Before last week, stocks had gone up in a straight line for about two months. It was time for a pullback... and there could be more downside ahead and more awful headlines.
But there's a huge difference between a pullback and a market crash. Pullbacks are healthy. They provide investors opportunities to buy their favorite stocks lower.
A crash is defined as more than a 20% decline in the market. Based on the fundamentals and favorable government policies, I don't see that happening over the next 12 months.
Giant cell-phone chipmaker tumbles to new low... Qualcomm slides 15% in a month.
Brazil fund EWZ craters... down 11% last week, approaching three-month low.
UK stocks fall 3% Friday... failure to elect majority gov't sends shares near six-month lows.