Saturday, October 11, 2008

Stocks could be cheaper now than in 1932

There's an article in today's WSJ I highly recommend, by Jason Zweig. He compares today with the conditions that prevailed just a few days before the absolute bottom of the stock market in 1932, after prices had fallen almost 90% from their 1929 highs. The summary: many stocks today are trading at levels that rival the ridiculously low valuations that the famous Benjamin Graham, the father of value investing, discovered back then. Here are some excerpts:

The nation was in the grip of what U.S. Treasury Secretary Ogden Mills called "the psychology of fear.

More than one out of every 12 companies on the New York Stock Exchange, Graham calculated, were selling for less than the value of the cash and marketable securities on their balance sheets.

Out of 9,194 stocks tracked by Standard & Poor's Compustat research service, 3,518 are now trading at less than eight times their earnings over the past year -- or at levels less than half the long-term average valuation of the stock market as a whole (according to Graham's calculation methodology).

Nearly one in 10, or 876 stocks, trade below the value of their per-share holdings of cash -- an even greater proportion than Graham found in 1932. Charles Schwab Corp., to name one example, holds $27.8 billion in cash and has a total stock-market value of $21 billion.

Those numbers testify to the wholesale destruction of the stock market's faith in the future.
This market is priced to a belief that we are in the early stages of a profound recession or perhaps even a Depression. If you believe the future is just a tad brighter than that, you should be buying stocks today with abandon.


Tory Conservative said...


I keep reading that the bond rating agencies didn't perform the way they should have in this financial crisis. They rated securities backed by mortgages with little or no payment and little income or credit verification too high. Financial institutions relied on these rating agencies (I assume this is Standard and Poors - Moody).

Also I have read that the FDIC engages in "risk scoring" where it assigns a risk score to assets in a bank's portfolio. It assigned a mortgage with a 20 percent down payment a risk score of 35. But it assigned securities backed by risky mortgages with a risk score of 20.

This apparently encouraged banks to purchase mortgage backed securities rather than originate their own mortgages with their own lending standards and oversight.

Can you explain the problem with the rating agencies? Is the government preventing adequate competition among rating agencies?

And how influential was the FDIC's risk scoring in encouraging banks to make bad loans, in your estimation?

Scott Grannis said...

The rating agencies do share a significant portion of the guilt burden here. In their defense, though, they were making reasonable assumptions at the time, namely that housing prices wouldn't collapse (but they did collapse). The things they rated AAA had a very low probability of suffering losses, but in the end they suffered much bigger losses than predicted. And as the agencies learned quickly from the mess and lowered ratings repeatedly, they exacerbated the downturn because many investors were forced to sell the securities that had been downgraded. A vicious cycle ensued, and the rest is history.

I think the risk scoring was also a factor, since it gave banks an incentive to buy AAA rated bonds based on risky mortgages. Again, those securities were not thought to be risky, but that was based on the assumption that home prices were highly unlikely to decline as much as they have.