The most-asked question in financial circles right now is also the most impossible. When will the market hit bottom? Ask this of your financial adviser, or of a mutual fund manager. It's a good test. The more certain they are of their answer - the more certain you can be that you're dealing with a charlatan.
Here's how a realist answers the question. "I wouldn't know a bottom if it whacked me in the head," hedge fund manager John Clark said. "No one ever does." Now that's an honest response. While your portfolio was getting trashed, by the way, Mr. Clark's main fund, The Preservation Trust, earned 21.6 per cent last year. Maybe that's because he spends his time studying whether the banks are going to blow up, instead of worrying about whether the TSX is going to fall below 7,000.
Where is the bottom? Even Warren Buffett doesn't know and doesn't want to guess. The world's second-richest man wrote in The New York Times last fall that he was bullish on U.S. stocks - loading up on them in his personal account, in fact. But then he added this caveat: "I don't like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term." The Dow Jones industrial average has dropped another 22 per cent since then. That's why he's the second-richest now, and not the richest. (Hello, Bill Gates.)
On Monday, Mr. Buffett was on CNBC talking about how the U.S. economy had fallen off a cliff. Gasp! But then he kept talking. He was as certain as could be that investors who buy stocks today will find them a great investment over the next 10 years - or, at the very least, a much better investment than safer choices, like bonds or cash. The next day, the Dow went up 379 points, prompting a gaggle of pundits to declare that we've reached the bottom (or haven't). Who knows? Not them! If they did, they wouldn't be working for Merrill Lynch or CIBC. They'd be cruising around on their yachts and counting their money.
Where is the bottom? Millions of people aren't sticking around to find out. A study done last year by two Wall Street industry groups found that the number of U.S. residents owning stocks and bonds had fallen significantly since 2001. And even though the markets have been chopped in half, equities still aren't necessarily cheap, by recessionary standards. That's because corporate profits have fallen down an empty elevator shaft. The Standard & Poor's 500 index now trades at nearly 11 times earnings. But in the bone-crunching downturn of 1981-82, it got down to 7½ times. Same with the bear market of 1974.
Plus, profits are likely to keep going down for a while. No one knows where the bottom is for those, either. Dr. Doom himself, superstar economist Nouriel Roubini, said the other day that the Dow could drop to 5,000 based on exactly this reasoning. If the market fell that much, it would vaporize another $2.4-trillion (U.S.) of paper wealth in the United States alone, and trillions more elsewhere, no doubt.
So why is Mr. Buffett so optimistic? Because he knows that at a time like this, price-to-earnings ratios lose their meaning, because many companies have no earnings. That won't last forever. The better measure of the market is how America's businesses are valued, compared to what they can produce. In the late 1990s and early 2000, all U.S. stocks were worth nearly twice the gross domestic product of the United States. That was a sign of a bubble (and Mr. Buffett said so, in a now-famous article in Fortune magazine). Historically, he noted, the best time to buy was when the total value of the stock market was much less than economic output.
Today, after the crash, all U.S. stocks are worth roughly $8.5-trillion, and U.S. GDP is about $14.2-trillion. The Buffett Ratio is about 60 per cent. It hasn't been that low since at least the mid-1990s. We ran the numbers for Canada, and found exactly the same thing (see the chart). Equities are not as depressed as they were during the last two recessions, but they're back to where they were in the mid-nineties, which says that stocks are probably as safe an investment as they've been in at least a decade - provided, of course, you can afford to wait for years for your return. But does that mean the market is about to hit bottom? We're not going to fall for that one.