Struggling Stocks, Booming Commodities

04/28/2005

NASDAQ dropped -12.5% year to date in 2005. S&P500 index suffered -5.7% this year. US stock market has been terrible over past few months.

Not only general market is down, oil stocks recently had a significant correction as well. It is easy to be nervous because of the short term setback. However, to succeed with long term oriented value investing, we can not be distracted by the volatile short term market movement. It is time to step back and look at the big picture of the current stock market and review investment strategy to profit in this kind of tough environment.

Stocks in General and Oil Stocks

Below chart is past 1 year performance chart between Energy Index ETF (ticker: XLE) and S&P500 index (ticker: SPY). By looking at the chart, even a fool will know that oil market is booming while US stock market in general is struggling.

Simply put, the current US stock market is not in bull market. The heydays of 1980's and 1990's when anyone can simply put some money in S&P500 index fund or a decent US mutual fund to earn 10% to 20% plus annual performance is long gone. I expect for the next 8 to 10 years, the US stock market in general will be stagnant.

If you have believed that 20 years of stock market performance between 1980 and 2000 is stock market average performance, then you will be shocked to know that just before that period in 1960's and in 1970's, US stock market went nowhere. Dow hit 995.15 in 1966 and Dow was back to 800 in 1982. If you were the long term investor who invested in Dow index fund between 1966 and 1982, you got a negative -20% return overall for your 16 years of loyalty, how would you feel about that ?

Still remember the NASDAQ peak of 5000? In my opinion, NASDAQ is screwed up index with full of expensive stocks even today. I predict that we may have to wait another decade to revisit NASDAQ 5000.

Current Stock Market Average Valuation is Not Cheap

Currently SP&500 index trades at about 17x average PE today. Although this valuation is not terribly expensive, it is not that cheap either.

Over past 100 years of US stock market history, market usually bottomed at average PE of 10. That happened in 1974 or 1929 or 1980. We are not there yet, not even close over past 5 years even though the technology stock bubble bursted in 2000. In a major stock market bottom, we should see plenty of big cap stable companies trading at PE of low teens. Now look at this: Coca-Cola (KO) PE 20, Walt Disney (DIS) PE 24. Even worse, a no-growth stock like Sun Microsystems (SUNW) is still trading at premium PE of 19.

What is the Overall Earning Outlook of US Stock Market?

Even though the current stock market valuation is not that cheap, if earning is good, market should do fine.

Are we going to get excellent overall earning outlook in the next few years for the US stock market in general? Unfortunately, my answer is no. My take is that US stock market earning overall is decent, but not good enough to trigger a bull market. This market is still digesting the past bubble over-valuation coupled with poor earning outlook.

Here is one reason of my not-so-enthusiastic earning outlook: the rising oil and commodity prices.

The Booming Commodity price

Commodity and oil market has been booming since 1999 and the high commodity price is taking toll on overall stock market earnings. Companies need to pay more for the things needed in business: steel, copper, oil, natural gas etc. Historically, when commodity market was shining, stock market did not do very well, and vice versa. In 1960's and 1970's, oil and commodity had bull market run for nearly 20 years while Dow Jone index had horrible performance for nearly 20 years. From 1980 to 2000, the stock market soared while oil hit as low as $15.

The Bull Oil and Commodity Cycle Could be Very Long

Jimmy Rogers is famous investor who co-founded Quantum Fund together with George Soros. In his recent book titled "Hot Commodities", he is predicting that the current commodity bull market can last until 2013 strictly due to supply and demand.

In one chapter of the book titled "Goodbye, Cheap Oil", he clearly lays out the reasons why oil and natural gas bull market can last until next decade. This is as simple as supply and demand: rising demand coupled with declining supply.

The supply of oil and natural gas was diminished partly due to extremely low oil and gas price in 1990's. Over past 35 years, there was no major oil discovery in the world while the old oil fields deplete. Oil and natural gas production level of a well does not stay flat over the life of a well reserve. The production level of a well actually declines gradually due to geophysics of oil well until the reserve is fully depleted. Even there is new oil field discovered, it will take a decade after the discovery to actually produce oil! Increasing supply to meet demand is a very difficult and slow process.

Coupled with declining supply, the demand of energy from China doubled since 1990 consuming 8 percent of world's oil in 2004. US economy is growing with increasing oil demand year over year while US oil production has seen sharp decline over past 50 years.

Still the oil price is not that high on historical basis. Even with today's oil price of $50 a barrel, the oil price is still significantly lower than the inflation adjusted peak price of $90 a barrel in 1970's.

Value Investors Do Not Need a Bull Market to Make Money

As scary as the potential trouble in stock market, this kind of tough environment is great money-making time for value investors to pick up cheap shares.

Warren Buffet is the greatest value investor in the world. He averaged 20% annual investment performance over past 50 years. However, Mr. Buffet's performance in bear market of 1960's and 1970's was actually 30% per year return, much higher than his average performance.

Focus on Dirt Cheap Stocks and Booming Commodities Market

Stocks do not go straight up or go straight down. There will be huge run up or sharp sell off in short term. While market is not in good shape, this is and will be wonderful time for long term oriented value investors.

Commodity price is volatile. Just like stock market, commodity price does not go straight up or straight down. Although oil price weakened recently, I firmly believe that oil price is not going back to cheap oil price below $40 a barrel. As long as oil and natural gas prices stay high, oil stocks will do fine in its business. As painful as the recent sharp sell off in energy stocks, energy stocks in general are still very cheap and my investment strategy is to continue to stay long term oriented in them.

In the short term, it is very hard to know when a stock will go up or go down. But I do know that valuation and earning matters and investing in cheap stocks trading significantly below market average will be rewarding in the long run.

Article by Henry Lu of BlastInvest LLC, a premium investment newsletter publisher in Connecticut. Visit http://www.BlastInvest.com for FREE "how-to" investing assistance, web services and more.

---

The Secret to More Winning Trades is as Simple as Avoiding This Common Mistake

If you're a normal human being, your need to feel... Read More

Picking Mutual Funds to Outperform the Market

With over 6,000 mutual funds available, it may be tempting... Read More

Dont Ask Your Broker

Unfortunately, most of you who are reading my column are... Read More

Trading vs Investing

I often hear from people, "I don't trade. I invest.... Read More

How (NOT) to Buy Mutual Funds

When it comes to mutual funds, there is a lot... Read More

Invest, Be Wrong, and Make Money in the Stock Market

I have been trading for several decades and was an... Read More

Lifestyle Funds Provide Greater Security?

With the stock market stubbornly refusing to settle down and... Read More

How to Maximize Your 401k Mutual Fund Returns

When it comes to 401k's there is an overabundance of... Read More

Stealth Bull

If you have been watching the stock market at all... Read More

A Funny Thing Happened on the Way to the Stock Market

On the 40 year journey through the turmoil of a... Read More

Understanding Stock Market Indexes

A stock market index is a statistical measure of changes... Read More

Inertia

One of the basic laws of physics is that a... Read More

Trading Tips No 2: The Big Lie in the Stock Market

It is commonly reported that the stock market averages about... Read More

What is a Mutual Fund?

Ever wondered what is a mutual fund? A mutual fund... Read More

Pamplona, the Wild Investment Bulls

You remember (they show it on TV every year) the... Read More

Will the Stock Market be Lower in October?

The stock market often closes a week in the middle... Read More

Stock Market Investing: Knowing When (and when not) to Sell

One of the greatest challenges of investing in stocks is... Read More

Catnip of the Stock Market

I have watched my cat play with a bag of... Read More

Rebalance And Diversify

The stock market has not been very kind to your... Read More

Dispelling Illusions of the Stock Market

How can you dispel an illusion unless you look directly... Read More

Long-Term Investment In Todays Market?

The stock market is very unstable at this time going... Read More

Mutual Fund Ball and Chain

The broker told me not to sell because the mutual... Read More

So, What is This Stock Market Thing Anyway?

We've all heard of the stock market and probably have... Read More

Market Globalization

Just 30 years ago the stock market was a shadow... Read More

Lights of the Stock Market

There are red lights, green lights, blue lights and spot... Read More

Stock Valuation using the SMP Model

Disclaimer: Please note that I do not necessarily purchase, own,... Read More

Size Counts!

What the heck am I talking about?It is often said... Read More

How to Evaluate Load vs. No Load Mutual Funds

If you have been dealing with mutual funds for any... Read More

Trend Trading - Trading Stocks Using Technical Analysis and Swing Trading Strategies

Peter is a professional trader, Paul is not. Peter has... Read More

Analyzing Growth Stocks: An Important Focus For Any Investor

Analyzing growth stocks is an important focus for any investor.... Read More

Investing in the Stock Market

From the book 'The Stockopoly Plan' by the author Charles... Read More

Shorting Stocks ? The Basics, Part I of II

What does it mean to short a stock?This means that... Read More

Stock Market Volatility

In my opinion, due to the volatility of stock market... Read More