For investors, this year can't end soon enough. Luckily, it is indeed coming to a close, and as with each first week in January, the slate is wiped clean and we begin anew.
Indeed, the opening of a new calendar can permit us to reconsider the future. And while there's still plenty of rough news surrounding us, perhaps it's time to ponder a new thought: optimism.
There's no question that new beginnings can't fully erase the pain of the past year. Portfolios have shriveled, retirement accounts have shrunk and multiple bailouts for the finance and auto industries will take some time to fully play out.
Bad Times, Good Buys
Still, it's important to remember that stocks have rebounded in the teeth of terrible news before. The stock market looks to the future rather than the past. It is a 'discounting' mechanism, meaning that it is looking down the road to determine if stocks are undervalued or overvalued.
Andy RashConsider one of the darkest periods of market capitalism, early 1942. The U.S. was on the run in the Pacific, Nazi Germany bestrode much of Europe and a long war lay ahead. Turned out, that was a pretty good time to buy stocks, despite all the hardship to come.
More recently, stocks started to turn higher in the teeth of the brutal recession of the early 1980s. That turned out to be one of the great buying moments of a generation, as stocks roared through the 1980s.
Economists in early December declared the U.S. in an official recession, dating its beginning to late 2007. Ahead of that declaration, stock prices steadily declined.
On May 19, the Dow Jones Industrial Average closed above 13000. By Oct. 10, the Dow Jones industrials had fallen to less than 8500. The blue-chip measure then closed at its low for the year, 7550, on Nov. 20.
Since the recession declaration, the Dow Jones industrials have herky-jerkily worked their way back higher, flirting with 9000.
Is the market trapped in a range, or is it signaling that the worst is behind us and that things will improve?
There are many reasons to think that stocks are more likely to rise than fall in the coming year.
Positive Signs
For starters, recessions have averaged about 11 months in length since the end of World War I. The current recession is already that long, which means we are probably closer to the end of the downturn than to the beginning.
Second, stock-market valuations have become historically very attractive. Third, the Federal Reserve has taken short-term interest rates to nearly 0%, a record level. Fourth, the government has pledged guarantees and spent money totaling trillions of dollars. Fifth, the incoming Obama administration plans to spend perhaps as much as $1 trillion on a stimulus program.
That's a lot of firepower aimed at turning around the economy and, by extension, the stock market. And it comes when some stock-market valuations are at remarkably low levels.
General Electric (GE) trades with a price-to-earnings ratio (P/E) of about 8 and has a dividend yield of 7%. GE, a charter member of the 30 elite companies that make up the Dow Jones industrials, has usually sported a P/E in the midteens, and its yield has rarely been at this level. There are concerns about its financial businesses, but based on basic valuation measures, GE, which is trading around $16, looks cheap.
Software giant Microsoft (MSFT) now trades below $20, territory it has largely avoided for more than a decade. It has a dividend yield of 2.7%, a P/E of about 10, no long-term debt and a large stash of cash. While it faces competition from Google and others, it continues to grow and to throw off large amounts of cash.
Boeing (BA) is at its lowest share price (about $40) in nearly five years. Its P/E is 8, its yield is more than 4%. Boeing faces competition from Airbus, but it is part of an international duopoly that the government would never permit to fail.
To be sure, not everything looks so dirt-cheap. Consumer-goods companies like Coca-Cola (KO, about $45) and Procter & Gamble (PG, $61) have valuations that are historically more average than cheap. This is partly because investors see these companies as especially resistant to recession. People still drink soda and buy soap, even when times are tough.
So, is it time to buy stocks? Not willy-nilly, by any means. But considering the rock-bottom interest rates in the bond market, the still-fragile nature of the housing market and the precipitous decline in most commodity prices, stocks may be comparatively the smart play.
'Dollar-Cost Averaging'
Investors thinking about the stock market should consider two approaches.
First, since it is hard to spot an absolute bottom, you should use 'dollar-cost averaging' to invest in broad-based, inexpensive index funds. By setting aside a set amount of money each month to invest in the market, you will get more of the market when prices are low and not buy too much of the market when prices shoot higher.
Second, make sure that you are taking full advantage of your workplace retirement account. Again, focus on broad-based index funds.
While the record of recessions, combined with government spending and low interest rates, should augur well for the stock market, it is best to move ahead prudently and intelligently.
Be diversified and disciplined, investing from a position of financial health rather than weakness. This is not the time to ignore paring down your debt, for instance. The market looks cheap, but thrift should remain foremost in your mind.
