Time to sell based on real earnings? - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 16 September 2014
Time to sell based on real earnings? A  A  A

Gualfin, Argentina

The Dow rose back above 17,000 yesterday. All clear. Stock market investors: your money will probably not die today. Maybe tomorrow.

Does it really make sense to be in the US stock market now? True, there may be apples higher up in this tree, but it is dangerous to reach for them.

We came up with the Simplified Trading System a long time ago as a way to tell us when it was time to put the ladder away. We weren't completely serious about it then...and still aren't. Still, it's a great system. But only for people with the life expectancies of Methuselah and boundless patience.

The original idea was that there was a time to be in stocks and a time to be out. When you were out, you just stayed in cash. And since we're talking about long periods of being out, you should be in the cash that holds up over time- gold.

P/E < 10 = buy stocks. P/E > 20 = sell stocks. Otherwise = gold.

Simple? Well, yes and no. You have to decide how you're going to calculate P/Es, for example. Therein hangs a long and complicated tale. Forward earnings? Last year's earnings? Earnings averaged over 10 years? Normalized earnings?

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To put this in perspective, we are suspicious of today's earnings. Interest rates are pushed down artificially. This pushes up earnings artificially. We'd rather base our big trades on something more real. And right now, we guess that real earnings, adjusted to normalized interest rates, should put the P/E ratio way over 20...that is, long past our 'sell by' date.

Our old friend, market researcher Stephen Jones, says a better measure is market price/GDP, but we haven't gotten around to looking at it carefully.

Sure, STS can be improved. But had you followed the system since 1980 you would have bought stocks in the early '80s and enjoyed at least ten years of a substantial bull market. You would have made about 3 times your money by the time you got around to selling out. (At that point, the mid-90s, the better move would have been to put a trailing stop loss behind your position...but, who knew?) This would have put you into gold near its bottom. Let's say you bought at around $400 an ounce. Stocks have not fallen to a P/E, on last year's earnings, of less than 10 since. So, you'd still have your gold, now worth about 3 times what you paid for it.

If you'd started in 1980 with $10,000, for example, now you'd have about $90,000 - with almost no fees or trading costs along the way...and only one tax event, at capital gains rates. If you'd started with a million, you'd now have about $9 million.

Great? No. But not bad for making a total of two moves...neither of which was very risky.

But, of course, you would have missed all the fun of trading in and out...talking to your broker...watching Jim Cramer on TV and reading our newsletters. And today, you'd be sitting on a pile of gold, cursing us for having kept you out of one of the biggest bull markets in history.

But can you really expect to do better?

Maybe! We developed the STS because we don't have the temperament to do serious stock market research. We enjoy economics...and trying to put the pieces of the big puzzle together. We don't have a head for the painstaking, detailed work required of a real analyst.

But we've seen that a careful investor, who is willing to do his homework, can outperform the markets over long periods of time. We saw evidence in the track records of our own colleagues Porter Stansberry and Chris Mayer, for example, both of whom more than doubled the market averages over the last 10 years. Thousands of other investors have done likewise.

Go ahead and check them out ... And our feelings won't be hurt if you decide to subscribe to their services rather than our own. Still, you might be better off reading my letters too. Besides the Diary is free. You can't beat that. The cost in time...well, we try to make it worth your while.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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