Is it time to sell everything or buy with abandon? Investors can't make up their minds. This week was one of the most volatile in the history of Wall Street. The Dow Jones industrial average swung more than 400 points four days in a row - down, then up, then down, then up.
It's frightening, but experts say the fear results partly because memories of the financial meltdown of 2008, when stocks lost half their value, are fresh.
Their advice: Hold tight. It's not time to sell, but it's probably not time to pour money into stocks, either.
The Dow finished Friday with a gain of 125.71 points, or 1.1 per cent, to 11,269.02. It finished the week down 1.5 per cent after being down as much as 6.3 per cent for the week.
The broader S&P 500 index rose 6.17 points, or 0.5 per cent, to 1,178.81. It finished with the week down 1.7 per cent. The technology-focused Nasdaq composite rose 15.30, or 0.6 per cent, to 2,507.98. It lost one per cent for the week.
"The stock market has done so well historically that, even if it is overpriced, you're likely to do okay," says Robert Shiller, a Yale University economist famous for having warned against bubbles in technology stocks and housing.
Though he believes the stock market is still overvalued by historical averages, he says it is closer to fairly valued than before. He suggests investors move their money "modestly" into stocks.
A pair of widely respected gauges of market value suggest stocks are no great bargain. But since the Great Depression, shallow bear markets - drops of 20 per cent or so in stock prices - are much more common than the huge plunges of 2008.
Of the 12 bear markets since the Great Depression, only three have qualified as "mega-meltdowns," with drops of 40 per cent or more, says Sam Stovall, chief investment strategist at Standard & Poor's.
The market isn't quite in bear territory yet. The Dow closed up about one per cent Friday and finished the volatile week down just 1.5 per cent. Since the market's highs of April 29, the Dow is down 12 per cent. The S&P 500 is down 13.5 per cent.
Though history is only a rough guide, Stovall suspects that any coming bear market won't be as severe and will end quickly.
Bear markets last a year and five months on average.
Stovall is cautiously bullish. He says investors tend to dwell on the recent past when investing in stocks, so they're selling now because they fear a repeat of the 2008 collapse. In the year and a half ending March 9, 2009, stocks dropped 57 per cent.
If the financial crisis had happened in 1988, not 2008, it wouldn't be on most people's minds.
"The market is down because people remember getting sucked up in the previous bear market," Stovall says.
Should you buy now?
A lot of Wall Street pros say you'd be a fool not to buy stocks now. Prices seem low compared with what stock analysts expect companies to earn this year. But these pros are almost always saying to buy - and almost always too slow to lower their earnings projections when times get tough.
In recent weeks, they've barely touched their projections despite slowing US economic growth and mounting European debt problems. In fact, they expect US companies to make more money than ever this year.
Besides the possibility, the pros are too bullish about earnings, there are two major reasons to worry:
- Investors fear that Europe's debt crisis could spread to Italy and Spain and lead to big losses at European banks that have lent to the nations that are in trouble; and
- In the US, the Federal Reserve earlier this week signalled that it would keep interest rates super-low for two more years because of expectations that unemployment will remain high and economic growth slow.
The Fed's decision came after the government said the US economy had barely expanded in the first six months of this year. Fears have grown that the US could fall into a new recession.
Fortunately, the US is in better shape than before the financial crisis in 2008, so stocks may not crater. The financial system is more stable, and the biggest US companies have amassed an impressive rainy-day fund - US$1 trillion in cash.
Robert Doll, chief equity strategist for money manager BlackRock in New York, doesn't think a recession is likely, but he isn't ruling one out. Still, he is bullish on stocks because so many companies are making money overseas. That means trouble in the US economy matters less to US stocks.
"The US stock market and the US economy are increasingly unrelated," Doll says. "If the US economy is muddling through, the stock market can certainly rise significantly."Scooping up stocks
Curtis Jensen, chief investment officer of Third Avenue Manage-ment, also likes the international exposure of many US companies. His firm, which manages $15 billion in assets, spent US$210 million on Monday and Tuesday alone scooping up stocks.
But he adds that he doesn't think the S&P 500 is a bargain - only some stocks. "It's not time for the shotgun approach - buying the whole market," he says.
Stocks are cheap using one measure known as the forward price-to-earnings ratio, or forward P/E. For example, if a company is expected to earn US$4 per share over the next year and its stock trades at US$64, the forward P/E is 16. That's roughly the historical average.
Stocks in the S&P 500 are trading at a forward P/E of about 12, according to research firm Capital IQ. If you believe analyst projections, that suggests stocks are a bargain now. You're paying less for each dollar of expected earnings.
At that price, investors far from retirement age, or those without much savings in stocks, may feel like buying.
The problem, says Yale's Shiller, is it is difficult for investors to judge whether to buy by looking at a single year's earnings for companies - much less estimates of a year that hasn't started.
Earnings vary year to year depending on business cycles. So his idea, championed first by investment legend Benjamin Graham in the Depression, is to divide stock prices by their average annual earnings over a decade, adjusted for inflation.
Using that measure, stocks in the S&P 500 are trading at 20 times their earnings - hardly cheap. That is about the average for stock prices over the 50 years, suggesting stock prices now are pretty much where they should be.
Another way of looking at stocks is to compare their prices with Federal Reserve estimates of something called book value - what a company would have left if it had to shut down, sell its assets and pay back its lenders.
According to Andrew Smithers of Smithers & Co, an investing consultancy in London, stocks over the past century have traded at about 0.64 times this measure. Today, the S&P 500 is trading at 0.93 times - suggesting stocks are too expensive. Smithers says he is not buying now.
"I'd be wary of putting too much in the market," says Shiller. "There's a good chance they'll fall. It's hard to predict the market."- AP