Ben Morris: Dan, what is the most important idea or trend for traders and investors to be informed about today?
Dan Ferris: Financial assets are overvalued. When most people think about financial assets, they think about stocks and bonds. So let’s look at those…
The tightest correlation with forward 10-year returns in stocks is household equity holdings as a percentage of assets. It’s a better forward indicator, historically speaking, than anything else.
[ad#Google Adsense 336×280-IA]Today, around 52% of household assets are in equities versus a 44% historical average. In other words, folks in the U.S. are as committed to stocks today as they were in the late 1960s, 2000, and 2007. All three of those periods were followed by lousy returns.
A couple more metrics have historically correlated well with forward 10-year equity returns…
Stocks as a whole, measured by the S&P 500 Index, trade at a price-to-earnings ratio (P/E) of about 24.
Over the last 50 years, the S&P 500 has traded with an average P/E of 16.5. So we’re well above that now.
Another metric I’ve been looking at is the market cap of all U.S. stocks compared with the country’s gross domestic product (GDP). Historically, stocks have been cheap when the total market cap is at or below 100% of GDP.
My research partner Mike Barrett and I refused to recommend stocks earlier this year, when the market cap reached 150% of GDP. And today, it’s still around 140%.
That’s sort of like saying all the public companies in the U.S. are worth 40% more than what they produce, plus the rest of the economy.
Stocks are expensive.
Regarding bonds, just look at the 10-year U.S. Treasury. Today, it yields around 1.5%. Let’s be conservative and say that inflation runs 1% a year. That leaves you with a real return of just 0.5%. It just doesn’t make sense.
It’s not the greatest idea to bet on a government when yields are this low and when government debts and other obligations are this big.
We have a robust economy. But the longer this goes on, the worse it will get. Eventually, people just don’t pay back this much debt. Between government debt and entitlement programs, it’s too much.
One way to get on the right track is to cut expenses. But expenses never get cut for political reasons. The easy option is to print more money to pay off debts… to inflate it away. That’s the most likely outcome.
The yield on the 10-year Treasury is often called the risk-free rate of return. But buying government bonds today is more like return-free risk.
Ben: Why is this especially relevant now?
Dan: People tend to want you to tell them some kind of magic trick or tip that will be super profitable. That’s a mistake.
Negative advice is more useful than positive advice today. My negative advice: Don’t buy most stocks. Don’t buy speculative garbage. Don’t buy most things that are put in front of you.
That doesn’t sound sexy to most people. But investing shouldn’t be sexy. It should be boring. Right now is when you really can’t afford that kind of “magic trick” mentality.
Think about it this way… If you’re picking stocks and bonds for yourself, you never want to buy anything that’s expensive. Look for good businesses with good industry conditions… Have somewhat of a contrarian viewpoint. If you don’t, you’ll never get a good deal. Learn to think about the risk in the business.
The trick today is to not do anything different. At the bottom, that results in buying more stocks, because they’re great values. At the top, it means buying fewer stocks, because they’re not good values.
Investing doesn’t have to be about being smart. You just have to behave better than most investors. If you don’t behave well near the top, you won’t have money left for good deals at the bottom. Behaving better is the competitive advantage that’s always there for anyone to pick up and run with. It’s the easiest way to outperform others in the stock market.
Ben: Do you suggest readers do anything differently today?
Dan: In Extreme Value, we’ve been shorting stocks. When we sell a stock short, we flip our criteria for buying a stock upside down.
We like to buy companies that have good management teams, large profit margins, plenty of cash flow, and a good competitive position. We tend to find better businesses among companies that are among the top two or three in their industry.
But when we go to short, we choose companies that have a competitive position that’s getting worse and worse, and is in fact beyond the point of no return, but that we feel the market hasn’t really punished enough yet.
You can find a company that is down 50% or 60% and it can still be a good short. Usually, stocks that trade at 52-week lows don’t perform well going forward. Scott Fearon – the author of the book Dead Companies Walking – likes to short only when a stock is down 50% or more.
Ben: What industries or sectors are you most interested in shorting?
Dan: Retail is the best industry for shorts. It’s a brutally competitive industry. Odds are exceedingly rare you’ll find the next Wal-Mart (WMT) or Target (TGT). Most retail stores go out of business.
Ben: How about value? Are you finding any good values out there?
Dan: There are some screaming deals in miners. Especially in the metals that haven’t risen yet, like uranium and copper. There are good values among gold stocks, too. But copper stocks are cheap compared with gold. That’s a good area to look for value today.
Ben: Good stuff. Thank you for your time, Dan.
Dan: You’re welcome.
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Source: Growth Stock Wire