Hussman hits on two of the three critical issues: profit margins (which will mean revert negatively) and the distinction between reported earnings and operating earnings (use of the latter makes the P/E appear lower than it really is). (Although Hussman doesn’t mention the more pervasive use of stock options these days as compared to decades ago which dilutes the real P/E.) I think there’s one more issue to think about (with respect to the S&P specifically): dividends.

Prior to the late-1980s, dividends comprised almost half of the 10% annualized long-term return on the S&P. Well, the current dividend yield is about 1.5%. If you assume 6% nominal long-term earnings growth (3% inflation + 1.5% population growth + 1.5% productivity growth), that gets you to a return of 7.5% annually on the S&P over the long term IF MARGINS AND VALUATIONS REMAIN HIGH, as they are currently, which has historically been a bad bet. The other issue is that the risk-free return on the 10-year treasury is about 5.25%. If you’re willing to accept the volatility of the S&P (standard deviation of about 20% per year) to get a 2.25% premium over risk-free treasuries (standard deviation of about 5% per year), then you’ve got a very unusual appetite for risk. And, again, that 7.5% is a very optimistic projection.

Assuming some mean reversion on margins, the S&P probably won’t return more than about 5% or so over the next decade. That’s not particularly exciting considering that you can get 5.25% risk free owning treasuries. Stocks generically are a sucker’s bet right now.

Here’s an answer to the investing question from my brother, a brainiac attorney with a masters in computer science, a law degree from one of the top law school and who worked on Wall Street before coming to SD. He also reads an hour or two every day, economics and politics.

He recommends diversifying in a porfolio of commodities and East Asian and European mutual funds. If the yen goes up, so wil the East Asian funds. If the euro goes up, so will the European mutual funds. When the dollar falls, all three will go up. This way, you are betting against the dollar on top of making good investments.

Warren Buffet is making his new investments outside the US. He bought an Israeli company. So people who believe the dollar will fall, invest in non-US companies.

My brother and I disagree on whether the anticipated reduced US consumption will effect Asian and European stocks. He says Asia doesn’t need us; they’re selling us goods in exchange for IOUs, worthless paper (Tnotes). Since they’re not converting our dollars to their currency, they are not getting paid anyway. So when the US consumer slows down on Chinese goods, the Chinese will selling those goods to themselves. This does make sense, but if they don’t need us, then why do they continue selling to us with these supposed worthless dollars?

A reason that stocks/equities globally can decline somewhat in the next 6 weeks has to do with the yen carry trade. some guess that the Japanese carry trade, which put $200 bil of liquidity into the system and is unwinding by end June 2006, was used to buy equities and bonds. As these positions are liquidated between 3/06 and 6/06, the equity and bond markets where the investments were made, will go down. You can read more at atimes.com. They wrote that “the end of quantitative easing will pull an enormous amount of liquidity from Asian and US stocks and bonds, prompting widespread asst price depreciation and yen revaluation”.

Have you talked with Chris J about trading bond futures? I just subscribed to his service. You make 1-2 trades per week. Get in, hold for several days, get out. He makes his living at this, and has done well. Check out his blog.

I would love to know some good ideas for investing. I have made many posts about this, but don’t get many responses. I’m glad you are bringing up this topic.

What have you found out from the other sites?

The manic phase* in this commodities / precious metals bull market will likely make the dot-com mania look tame by comparison.

There is no fever like GOLD FEVER!!!!!

We are still a few years away from the mania stage, IMO. I can tell by the reactions I get when I talk about silver and gold.

When everyone agrees with me that silver and gold is the place to be, I will be selling.

*Bull markets have three phases
1. accumulation by smart money
2. institutional investors recognize the new trend and start buying
3. mainstream investors / joe public recognize the “new” bull market and rush in – this is the mania phase – every stock with ‘gold’ or ‘silver’ in its name will be soaring

see http://www.zealllc.com – Adam Hamilton provides a wealth of information for free – he updated his “Gold Bull – Stage Two” analysis on 5/5/06

Fall is generally a good time to buy stocks. A very high percentage of the historical gains of the stock market have come between Nov and April 1. This is the time of the year to be looking for a rally. Timing it is another discussion. However, assuming the circumstances are right at the time, approx. Nov. 1 is the seasonal low spot.

This year with the mid-term congressional election cycle, and a larger scale 4 year cycle supporting it, there is a good backdrop to look for a rally in stocks.