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Welcome to the first edition of Zacks.com's Weekend Wisdom.
With the ongoing market turbulence, I'm sure you have many pressing questions. When will the market bottom? When will it be safe to go back into stocks? What can I do to start rebuilding my wealth now?
To answer these questions we've created this special commentary, Weekend Wisdom. Every Saturday, we will publish an article focused on the most important stories that affect the market and your wealth.
Why Saturday? Because we realize it's hard to keep up with all of the market news throughout the week. The weekend provides time to reflect on the broader trends and how to adjust your portfolio accordingly.
We hope you enjoy Weekend Wisdom and welcome your feedback. Just click on "feedback" at the bottom of this article to give us your comments.
Why Hasn't A Bottom Been Set?
The one question I routinely get from friends and acquaintances is "when will the market hit bottom?" I'm sure you want the answer too.
Months ago, I said the Dow Jones Industrial Average ($DJI) would hit 6,300. At the time, that sounded like a shocking prediction. I even followed my prediction by saying "I hope I'm wrong."
Unfortunately, it's looking like I was pretty darn right.
But will 6,300 be a bottom?
I wish I could look you in the eye and say yes it is. But the data gives me reason to be cautious. I don't know what fair value for the Dow or the S&P 500 is. And neither does anybody else.
Can't Buy What You Can't Price
My target assumed the average P/E multiple for the Dow would fall close to single-digits, something that has not happened since the mid-1980s. (The major indexes have traded at single-digit P/Es during various periods throughout market history, often in response to economic peril.) The math works if I know approximately what earnings are going to be. But I don't have much faith in the current profit forecasts, and neither should you.
The reason is that brokerage analysts continue to cut their full-year forecasts across the board.
Let me give you an example. Last November, the 2009 top-down S&P 500 consensus earnings estimate was $93.73. Now, the consensus estimate is $61.76. That's a 34% reduction in a period of just 4 months.
Is the consensus forecast going to go lower? Yes. How much lower? One analyst is saying $40 per share, but a few months ago, the most pessimistic analyst said earnings would total $75.20.
Knowing this, do you blame me for being cautious?
Going back to the math, P/E is price divided by earnings. We can figure out the price by looking at a quote page. But what do we divide the price by? $61.76? $40? The lack of visibility is perplexing even to those paid to make earnings forecasts.
Put another way, suppose you walked into a store and saw a shirt you liked, but there was no price tag. Naturally, you would ask a sales person to look up the price. But what if she couldn't tell you the price? You would either try to buy it for what you think is a really cheap price or walk away.
This is what is happening with stocks. Nobody wants to overpay, but they can't figure out how much stocks are worth. It's frustrating for everybody.
Bargain Hunters Skittish Too
Adding to the frustration are the constant new lows for the major indexes. Ever since Bear Stearns went down, the market has been establishing lower highs and lower lows.
For investors trained to buy on dips, this is painful. Every failure of the market to rebound causes another bargain hunter to lose money. This results in a downward cycle where would-be buyers keep their toes out of the water, causing stocks to fall further and force even more investors to the sidelines.
At some point, prices will get so low that investors will set their fears aside and start to buy stocks. This day will happen without any foreshadowing. We will all wake up and realize that the bottom has been set.
So your strategy is to maintain exposure to stocks while managing your risk. How do you this? We'll have to go back to 1934 for the answer.
Invest With a Margin of Safety
In the midst of the Great Depression, Warren Buffett's mentor, Benjamin Graham, published Securities Analysis. In this nearly 800-page book, Graham advised looking for stocks trading at low enough valuations to provide a cushion in case things got worse.
It's good advice that holds true today. Take a look at what analysts are forecasting and ask yourself if those estimates were 10% lower, would you still consider the stock to be a bargain? The idea is not to find the absolute cheapest stock, but to find a good, stable company that is now "on sale" thanks to the market.
In other words, you're assuming that the forecasts are too high, but you are still getting a good enough deal on the stock that it doesn't matter.
The other key is to look at companies with earnings estimates that are holding up reasonably well. With more than 800 Zacks #1 Rank ("strong buy") and Zacks #2 Rank ("buy") stocks, there is simply no reason to even consider investing in a troubled company.
This the strategy I have been following in managing the Zacks Elite Focus List. Stocks added over the past several weeks include Omnicare (OCR - Snapshot Report) and Shanda Interactive .
Omnicare provides geriatric pharmaceutical services. Nearly all of the 10 covering brokerage analysts have raised their full-year profit forecasts over the past 2 weeks. OCR is a Zacks #1 Rank stock and trades at just 9x projected earnings.
Shanda Interactive is a Chinese provider of online games. Though this is a big growth industry, fears about the global economy have kept the stock cheap. SNDA trades at just 10.4x projected earnings. The valuation is even cheaper when you consider that 5 of the 11 covering brokerage analysts raised their profit forecasts over the last week. SNDA is a Zacks #2 Rank stock.
Charles is the Senior Market Analyst for Zacks.com. He manages the Focus List and other portfolios on Zacks Elite. This service was rated the #1 best-performing stock newsletter over the past 10 years by independent Hulbert Financial Digest. For details on Zacks Elite and an opportunity to try it free, click here.