What a difference a year makes

Last January I was beginning to get tired of reading stuff like “kitchen sink quarter” and “this is a great time to buy real estate” and “this is the time to buy stocks”.  One evening I happened to read a post by Doug Kass entitled “Buy the Financials. Yes, Buy” in which he made a case that it was a good time to buy the financials using XLF as a proxy.

You can read my original post here, and Doug Kass’ article here.

Anyhoo, I happened to be looking at XLF today, because I’m interested in FAZ – a 3x financial bear ETF that I sometimes use – and I decided to revisit my original post and update the numbers.

Mr. Kass mentioned the S&P 500 estimated earnings as one of the basis for his buy call.  At the time of his post, the estimated earnings for 2008 were $80.  2009 earnings estimates were at $85, and 2010 earnings estimates were at %90.

2008 earnings aren’t totally in yet, but S&P is now estimating them (clicking on the link will open an Excel file from S&P with these numbers) at $65.73 – which I think will turn out to be too high.  As to 2009 earnings, S&P has the current estimate at $81.52.

I’ll bet anyone as much money I can scrounge up that the 2009 earnings estimate of $81.52 is too high.  Does any rational thinker actually have reason to believe that 2009 earnings will come in 24% HIGHER than 2008?

My guess (and it’s only a guess) is that 2009 will come in closer to $40 or $50 than $81.  In other words, I think the current price for the S&P 500 is almost double what it should be if investors are looking at the earnings.  So no, this isn’t the bottom.

I didn’t think it was anywhere near the bottom last January when I said “I think it’s waaay to soon to be looking at this sector.  Personally, I think we’ll see a couple of big bank failures before the financial house of cards has collapsed fully.  No, I don’t know who it will be, but I do know that you don’t make money in the long run by borrowing money (especially at today’s higher rates) to pay down debt”

Side note – A few years ago my brother had an email signature line that said “Tis a vain man who quotes himself”.

Since I wrote the prediction of “a couple of big bank failures” last January, we’ve all seen the collapse of Bear Stearns, Lehman Brothers, IndyMac, and Washington Mutual.  We’ve all seen the trillions wasted on bailouts of Citi, Bank of America, AIG, and even GM and Chrysler.

I’ve previously posted who has been bailed out by the taxpayers.  The list includes Citi (multiple times), Goldman Sachs, Bank of America, Capital One (What’s in YOUR wallet?), Wells Fargo, Morgan Stanley/Dean Witter (We make money the old fashioned way), US Bancorp, and Regions Bank.

I think my prediction of “a couple of big bank failures” has been vindicated….

A year ago I said “we’re heading into a very rough period for almost all asset classes, but “soft” things like made up financial assets and corporate profits (measured in the dollar) will fare much worse than “hard” assets, such as commodities.  Another 20% to 30% decline from here is not out of the question, so sell some stocks and put the proceeds into simple money market funds or commodities.

So how did that prediction turn out?  Here are some numbers:

Asset Jan 16th 08 Jan 16th 09 Change
S&P 500 1373.20 850.12 38.09%
DJIA 12466.16 8281.22 33.57%
NASDAQ 2394.59 1529.33 36.13%
XLF 27.17 9.68 64.37%
Gold (GLD) 86.70 82.71 4.60%
Silver (SLV) 15.65 11.11 29.01%
Euro (FXE) 146.81 133.01 9.40%
Oil (USO) 71.85 29.86 58.44%

So you can see that basically every asset class has lost money during 2008 – but absolutely nothing has lost more value than the financials as measured by XLF.

Don’t misunderstand my intent in posting this – I’m not claiming to understand how everything works.  I thought that commodities would take off during 2008 as the dollar weakened because of all the debt we were taking on.  In fact I still think that the dollar is way over-valued and the slide towards zero will soon resume.  But it didn’t happen like I expected it to happen last year.

We did have a very nice commodities boom in mid 2008 – but that turned out to be a bubble.  I still think that commodities are going to go up long term, but I “misunderestimated” (to borrow a term from our idiot President) the world-wide slowdown that happened in 2008. Oil was especially hard hit when worldwide demand fell off a cliff.

Long term, the US dollar is toast and commodity prices (as measured in dollars) must eventually go up to reflect the worthlessness of the dollar.  This is being exacerbated by the Fed’s insistence on printing up boatloads of worthless currency to use to bail out banks.  My advice is still to buy gold and silver.   Physical gold and silver – not the ETF’s.  Because when I say the US dollar is toast, I mean it.  You’ll want physical metal in your hand when our currency starts to look like Zimbabwe.

That’s a bit of an exaggeration to make the point, but inflation is going to take off at some point – it’s simple supply and demand.

I’m very happy that I moved money from stocks to a money market fund early last year.  I left 20% in US stocks, bonds, and overseas funds, and I kept putting my new 401K money into an S&P 500 index fund, so I still lost about 10% in my 401K last year.

So what’s going to happen this year?  In my opinion, the financials will drop more.  Their share values are being diluted every time the Fed does another round of bailouts – and that won’t end anytime soon.  Earnings will follow the same trend they did in 2008 – and stock prices will reflect the lower earnings.

Another side comment.  Have you noticed that stock prices tend to rise during earnings season?  No matter how bad the earnings actually are?  That’s because investors still want to believe that this is finally the “kitchen sink quarter”, they want to believe that all the writedowns and bad news are finally out there for everyone to see.  But they’ve been wrong for 5 straight quarters, and they’ll be wrong for at least a few more quarters.

After all the earnings have been reported, stocks tend to drop because everyone starts thinking that maybe it is that bad.  That the next quarter earnings are going to be even lower.  And prices drop until the next quarter reports when the cycle starts again.

If you’ve been to a mall, car dealership, or hardware store lately, you know that traffic in those stores are way down.  So are sales.  Which means profits will also be down.  So I don’t think this will turn around anytime soon.  4th quarter 2009 is the earliest that I think could bring an improvement in earnings – but that may change depending on how deep this recession turns out to be.

IF my earnings estimate ($40 to $50 for the S&P 500) turn out to be close to correct, you can expect to see the DJIA around 5000 and the S&P 500 around 500 sometime this year.  That’s another 40% drop from current levels.  So I think you’ll come out ahead by selling stocks (even after the big loss you might have taken in 2008) and putting your money into a money market account for now.  And I think putting it into gold and silver now will pay big benefits when (not if) inflation takes off.


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