Buy Now or Wait? The Pros and Cons. (posted 3/14/09)


Today I received JP Morgan’s latest “Eye on the Market”, written by Michael Cembalest, CIO of Morgan’s Global Wealth Management. I think it is one of the better such communications from the street. The chart below was on the 3rd page, indicating that by the measure of price divided by tangible book value, the stock market has yet to return to the valuation range that prevailed for forty years, from 1950 to the early 1990’s.


The subject of the article was a discussion of the pros and cons of putting money in the market today.  It’s a good list that I found convenient to use as points of departure for my own thinking. I summarize JPM’s  letter below, along with my comments in bold italics:


Reasons to INVEST NOW

·       Global fiscal stimulus is on the way

(But the stimulus in the Eurozone is small compared to the U.S.)

·       U.S. monetary base has expanded rapidly…..central bank credit creation is roughly equal to the decline in private sector lending in U.S. and Europe

(Actually, while M1 and M2 have been expanding rapidly, M3, the broadest measure of money supply, has grown only 6.2% year-over-year, equal to only 1/10th of the growth of the monetary base. But I believe that monetary expansion is likely to be more effective in softening the decline in the months ahead than the stimulus package)

·       The Fed’s program to restart asset-backed credit markets is about to begin, with $1 trillion of capacity

(I have high hopes for this program; aggressive investors seem to be enthusiastic.  It might work to stabilize asset prices and get the securitization markets going again.  Watch it closely)

·       Loan modification programs will probably slow foreclosures

(Although the record on this is not good so far.  Many defaulted mortgages, presumably saved, have quickly slipped back into default)

·       Unemployment is a lagging indicator, so deteriorating employment conditions are less of an obstacle at the point in the cycle

(I disagree with this.  The rapid and substantial decline in jobs in this downturn may well make unemployment a leading indicator. See the article posted on this blog written by Larry Chimerine on this)

·       Short positions, while lower than last summer’s peak are still quite high

(Large short positions did not do the market any good last fall)

·       Few sectors have any optimism remaining

(This is certainly true)

·       Uptick rule is likely to be reinstated

(I don’t believe this would be any panacea.  Prices are not manipulated by short sellers the way it’s often pictured. Most value destruction would have taken place anyway)

·       There is lots of cash earning close to nothing

(absolutely……..and it can move rapidly given any incentive)

·       Mark-to-market accounting rule may be relaxed

(I’m not sure this does any good this late in the game, after most of the harm has been done. But if it were to help stabilize asset prices, it would be a big plus)

·       Assuming normalized earnings of $65 for 2010, a 13 multiple produces a price of 850, a gain of 16% from here

(I don’t think normalized earnings are as high as $65. More like $50-$55.  At 13x the market is just where it should be. But note in my February Musings, that measured by the Shiller P/E, stocks can get considerably cheaper)


Reasons TO WAIT

·       Vikram Pandit’s memo to Citi employees, which sparked the current rally, referred to earnings before provisions and writedowns.  This is important because their asset quality is deteriorating further this quarter

(I continue to maintain that the financial markets are unlikely to recover in any substantial way until investors have reliable evidence that the quality of bank assets has stopped declining.  Right now that looks to be a long shot for many months ahead)

·       Large hits to earnings are coming from unfunded pension obligations

(Agreed. Even worse are the obligations of states and municipalities, making tax cuts at the state and local levels almost impossible)

·       There is too much optimism on China. Actual 2009 stimulus is a third or a quarter of the U.S. level.  G20 stimulus is quite small

(Chinese exports, which account for about 40% of China’s GDP, fell in February by 26%, after dropping 17.5% in January.  Imports, reflecting the slowdown in domestic demand, fell 24%. Hence, questions still abound about the strength of the Chinese economy, which is the major hope for moderating the global economic decline.)

·       U.S. equity markets are effectively closed. Dividend cuts are being used as a primary way to raise capital

(GE, Dow Chemical, all the major banks so far, and many more to come will be cutting dividends.  See my posting of 3/4/09 for more on this subject)

·       Housing is a bottomless pit.  There are now 19 million homes in the “held off the market” category, that is looking like a pent-up future supply

(There are some brighter things appearing here.  Lower prices and lower interest rates have caused affordability to jump nicely.  And with starts below 500,000, and household formations running at 1.6 million, some pent-up demand is being created)

·       Treasury funding needs are staggering.  Part of the funding may have to be provided directly by the Fed

(Fed monetization of the deficit is a dangerously inflationary action; at least at some point we will have to worry about this)

·       Massive overcapacity in manufacturing…now at 71% utilization

(I’m not sure why JPM lists this as a negative. It’s a major reason why stocks are down so much. Obviously, in the short-term it means huge downward pressure on selling prices, productivity, and margins.  But when the turn comes, the upside operating leverage will be very strong)

·       Credit card delinquencies are at a “worst ever” state

(True, and it will get worse.  Also, thousands of cards are being revoked or limited more tightly. Merideth Whitney estimates that over $2 trillion of credit-card lines will be cut in 2009, and $2.7 trillion by the end of 2010. That’s out of a total of $5 trillion, $800 billion of which is now being used)

·       Questions about the productivity benefits of the stimulus spending.  Three largest 3 targets of spending: water treatment plants, community development grants and road repair

(I had not thought much about this before. But I agree it should be a concern. The stimulus package, as I have said before, is a baby aspirin for a bad migraine)

·       Valuations still not cheap enough

(I agree. See chart above, and my February Musings discussing the Shiller P/E)

·       Problems in commercial real estate, unfunded municipal pensions, intense pressures in Eurozone and Japan, Eastern European implosion

(JPM lumped these items together as a kind of after thought.  Each one is a serious problem. Can the Euro survive not having a unified fiscal policy? The recent Swiss intervention to wipe out the appreciation of their franc was dramatic news and smacks of possibilities of future competitive actions by other nations. Are the Japanese next?  And what must China think at this point about their currency?

I have nothing specific to say about commercial real estate, but the trends here are not good)


JPM’s conclusion?  Moderately underweight (by10-14%) equities.  They say they cannot identify the bottom perfectly, but expect it to occur in 2009.


On balance, as you might surmise form my comments, I am even more inclined to wait than JPM is.  I have never seen the economy fall this much this fast, and I have watched closely for over 50 years.


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