Don’t Buy the Dip…Yet

It was finally enough.

More than an 8% decline from the Dow and the ASX 200, and investors are back in.

According to Bloomberg, the cash held by brokers is at record lows. Wait, what?! So instead of selling people are buying? That’s not what it looks like…but that’s what’s happening for many mom and pop investors.

From Bloomberg:

The rift between Wall Street and Main Street is getting wider when it comes to stock investing.

For the third week in a row, individual investors bought stocks while institutional and hedge funds were net sellers, data on client flows compiled by Bank of America showed. Thanks to retail demand, equity buying by all the firm’s clients rose last week to the highest level since late May.

MoneyMorning 29-10-18

Source: Bloomberg
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If you stop and listen you can still hear the mainstream cry ‘buy the dip!’ from last week. Yet according to one investment officer, that might not be the smartest move.

If you’re on the hunt for the best paying dividend stocks, check out our income specialist Matt Hibbard’s free report here with the top five dividend stocks on the ASX.

Take a look at this overvalued dip…

Vitaily Katsenelson writes:

My business is to constantly look for new stocks by running stock screens, endlessly reading (blogs, research, magazines, newspapers), looking at the holdings of respected investors, talking to a large network of investment professionals, attending conferences, scouring through ideas published on value investor networks, and finally, scouring a large (and growing) watch list of companies to buy at a significant margin of safety.’

And with all that said, Katsenelson is still finding it hard to find solid companies with attractive values.

Take a look at the following chart. It shows how much the PE of the S&P 500 has deviated from its historical average.

MoneyMorning 29-10-18

Source: Real Investment Advice
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According to Katsenelson, the average stock on the S&P 500 is 73% above its historical PE. This means investors are paying more than 73% more than they normally do the same amount of average earnings.

These figures were taken in September of this year. To incorporate the current drop, the PE of the S&P 500 is more like 38% above its long-term average.

Katsenelson suggests that it’s only a matter of time until PE multiples revert to the mean, as they always do. He also points to the Buffett Indicator, which pairs market values of stocks to gross domestic product (GDP).

You could call it another way of measuring price-to-sales (PS), as GDP is simply the value US businesses get for their goods and services.

MoneyMorning 29-10-18

Source: Real Investment Advice
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Katsenelson writes:

This chart tells a similar story to the first one.

Though I was not around in 1929, we can imagine there were a lot of bulls celebrating and cheerleading every day as the market marched higher in 1927, 1928, and the first 10 months of 1929. The cheerleaders probably made a lot of intelligent, well-reasoned arguments, which could be put into two buckets: First: “This time is different” (it never is). Second: “Yes, stocks are overvalued, but we are still in the bull market.” (They were right about this until they lost their shirts.)

Yet it’s easy to explain why PEs and the Buffett Indicator are so high. Central bankers have pumped far too much money into the system.

They’ve printed cheap cash and given it out to whoever wants it, whether it’s a business looking to produce more, or a speculator looking to leverage his market position.

Activities like the latter have somewhat ruined investing for the rest of us. As Katsenelson points out, it’s not easy finding solid companies at cheap values.

Bond yields are so incredibly low that investors are willing to accept a potential 5% return on wonderful businesses. And it’s why PEs are still so far above their average.

As bond yields have risen in the past few weeks, the margin between potential stock returns and risk-free returns on government bonds is now very narrow.

I believe it’s why a lot of investors have sold out of stocks recently. Some may be tailoring their portfolios, selling a bit of stock A to buy a bit more of stock B.

But the majority are waiting for something better. And it’s why I believe stocks still have future to drop.

What should you do instead?

It would be lovely if we could all make 26% a year.

At such a rate your money doubles every three years. By year five, you’d turn $1,000 into $3,175.80. In another five you’d have $10,085.69. And in 30 years you’d be a millionaire.

But that’s just not how the world works, we can’t all make 26% a year. Sometimes the best we can do is 10%. And that might actually be a good return if everyone else is making 3%.

Yet I don’t think anyone is happy with where bond yields are right now. A 3.077% annual return over 10 years is what most investors have in mind.

It’s why I think sellers are simply holding cash, waiting for better opportunities. I wouldn’t suggest you sit on the sidelines like them.

There is no point sitting out, wasting your time. But now might not be the best time to buy anything and everything either.

Instead, be very selective. Approach each new investment like it’s the only one you’ll make. And, if it goes down initially, reassess the situation. If you still think it’s an obvious buy, buy more.

This market won’t fall forever, but I think we still have further to drop.

Your long-term pal,

Harje Ronngard,
Editor, Money Morning

PS: Also one to take the long-term view is our crypto expert Sam Volkering. He’s long believed the crypto story will take time to play out. The initial falls you’ve seen are just temporary. According to Sam, there is still money to be made and a system to revolutionise. It’s why he wrote Why 2018 Could Be the Start of a 2500% Bitcoin Bull Rush’, a guide/wealth strategy to help you understand and navigate through the crypto world. Download a copy here.

Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

Money Morning Australia is published by Port Phillip Publishing, an independent financial publisher based in Melbourne, Australia. As an Australian financial services license holder we are subject to the regulations and laws of Corporations Act and Financial Services Act.

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