As the disparity between stock prices and fundamentals set another record, investors are finally finding it impossible to ignore. Based on the annualized rate of decline in the second-quarter GDP, investing legend Jeremy Grantham points out that we now find ourselves in the top 1% of stock market valuations, but the bottom 1% of economic outcomes. Profit margins were relatively depressed during the Dotcom bubble, but profit in recent years became extremely inflated, which tends to make stock prices over the past few years look less expensive than they regularly would. If profit margins were normalized on a chart, stock prices today would be more expensive than they were during the peak of Dotcom Mania.
As it turns out, the current disconnect between stock prices and sustainable profits is greater than anything we have seen in modern history. The last time this type of absurd disparity occurred between prices and earnings, in the Dotcom era, the following decade (2000-2009), was referred to as “a lost decade.” If profit margins are only beginning to revert back to their historical mean, we just might be witnessing a déjà vu. It’s not at all unreasonable to think that today’s extreme in valuations could be responsible for pushing us into another lost decade.
Price and value are integral parts of an economic condition. When considering the current disconnect, it’s critical to realize that the most important distinction between price and value is that price is arbitrary, but the value is fundamental. In other words, I may agree to sell you a one .999 ounce gold coin for $500, which is an arbitrary amount chosen by me (the seller) and for reasons known only to me. As long as it is indeed a .999 one-ounce gold coin, even though its price is $500, its value is indeed much greater. Discrepancies occur in the stock market almost daily and trying to unravel the many factors involved could make your head spin. But in addition to market tendencies and even distantly related events, another weighty set of factors are driven by human characteristics and emotions, such as fear and greed. All of these factors can have a great affect on the price of a stock, but they rarely provide a significant affect to its value.
Given time and regular market forces, a stock’s price will quite naturally return to a level more in line with its value. Identifying and taking advantage of differences between price and value can be an effective investment strategy, but equally, not recognizing the differences can be a recipe for investment disaster. Price/profit disconnects, daily volatility, and an increasing global recession are just some of the factors that make the current stock market a dangerous proposition. Nevertheless, gold, silver, and other physical precious metals are still a safe and secure way of protecting portfolios, assets, and legacies, from the corrosive effects of today’s market conditions. Call the experts at America Bullion for assistance, before precious metal prices increase further. Don’t get caught without a chair when the music stops! Call American Bullion now, at (800) 653-GOLD (4653).
Although the information in this commentary has been obtained from sources believed to be reliable, American Bullion does not guarantee its accuracy and such information may be incomplete or condensed. The opinions expressed are subject to change without notice. American Bullion will not be liable for any errors or omissions in this information nor for the availability of this information. All content provided on this blog is for informational purposes only and should not be used to make buy or sell decisions for any type of precious metals.