News from Milestone Financial Advisors, LLC

Readers of this newsletter know that

I have frequently used historical antidotes in an attempt to illustrate that, in terms of economic cycle in general, and the stock market in specific, the more things change, the more they stay the same.

To grab a particularly obsure example, on the eve of President Truman's signing of the Revenue Act of 1951, which lifted the top marginal rate to 91% from 84.4%, George B. Haynes of Evanston, Ill. wrote a letter to the editors of Barron's Magazine excoriating the administration.

"I am (now) a bear on America for at least the next 10 years. The financial ignorance and recklessness of Congress and the administration, the willingness to sacrifice the country to (keep) the Democratic Party in power, the enormous Federal debt, the high taxes, the readiness to give billions of taxpayers' money to foreign countries can have, in my opinion, but one result, i.e., the worst collapse this country has ever experienced, though I do not know when."

One is immediately struck by the likelihood that this same letter could have been written numerous times since 1951, up to and including 2010.

This year, investors' moods have been particularly dour. After panicing out of the market during the bottoming process of October 2008-March 2009, market timers tiptoed reactively back into equities too late, as markets subsequently rose 83%. These same investors are now disgruntled as the market has see-sawed its way through 2010 with essentially no upside progress. (See Market Update, below)

What's a market timer to do?

We have all been hearing about the current "ten-year sideways market" as though nothing like it has ever happened before. (You know what's coming, don't you.) In fact, in December of 1974 the Dow Jones Industrial Average was trading at 577, roughly the same trading range it had been trading at for eight years going back to 1966. Furthermore, while the "price low" over those years occurred in December of 1974, the "valuation low" (when the index was at its lowest trading value relative to its book value) did not arrive until 1982. Thus, one could argue that the market was "sideways" for sixteen years during the 1966-1982 experience.

Burned by a manic "Mr. Market" since 2000, investors have been checking out of the stock market at record speed. Between 2007 and 2009 U.S. investors took more money out of stock funds than they put in, the highest three-year volume exit since the bottoming process of 1979-1981. Indeed, faith in equities has been all but lost, with investors on track to pull more money out of stocks in 2010 than in any year since the 1980s, with the exception of the 2008 melt-down.

As we all are well-aware, the stock market has been exceptionally manic-depressive over the past three years; but again, we've seen this before.

Here is Warren Buffett elaborating on Benjamin Graham's famous Mr. Market analogy:

"An ever-helpful fellow, Mr. Market stands ready every business day to buy or sell a vast array of securities in virtually limitless quantities at prices that he sets. He provides this service free of charge. Sometimes Mr. Market sets prices at levels where you would neither want to buy nor sell. Frequently, however, he becomes irrational. Sometimes he is optimistic and will pay far more than securities are worth. Other times he is pessimistic, offering to sell securities for considerably less than underlying value. Value investors, who buy at a discount from underlying value, are (thus) in a position to take advantage of Mr. Market's irrationality."

Clearly that is well-said, and it brings to mind a terrific article on Seeking Alpha's website last month titled "Mr. Market's 10% Opportunity", penned by Kendall J. Anderson, who

points out that a rarely-considered measure of common stock valuation is actually the reverse of the more commonly used "Price to Earnings" ratio. (P/E.) If you reversed the P/E equation and divided per share earnings by current share price, you have the "Earnings Yield" (E/P). Said Mr. Anderson:

"Here are a few points to ponder: 1) based on trailing 12-month earnings there are 71 companies in the S&P 500 with an Earnings Yield greater than 10%, 2) based on current fiscal year estimated earnings per share, there are 80 companies in the index with an E/P greater than 10%, and 3) based on estimated earnings over the next four quarters, there are 112 companies in the index with an E/P greater than 10%. Thus, given the number of companies you can buy with an E/P of greater than 10% you should be able to create a long-term portfolio that has a better than average probability of rewarding you with a higher return."

Finally, here is one last panic-inducing quip from Time Magazine (cover pic above):

"The US economy remains almost comatose. The slump already ranks as the longest period of sustained weakness since the Depression. The economy is staggering under many 'structural' burdens, as opposed to familiar 'cyclical' problems. The structural faults represent once-in-a-lifetime dislocations that will take years to work out. Among them: the job drought, the debt hangover, the banking collapse, the real estate depression, the health-care cost explosion, and the runaway federal deficit"

The piece was written in 1991. Sound familiar?