I'm not a big believer in trading off offundamentals
, but even if I were, it would be difficult to make the case that stocks are bargains at current levels. If March was the bottom in equity prices, it certainly wasn't so in terms of valuation. Even if the market does pull back from its recent rally, anyone planning on holding stocks for the "long haul
" should think carefully about choosing this moment to jump in with both feet.
Just consider the oft-cited workhorse of the investment world, the price/earnings ratio. It's worth noting that even now, after all of the bankruptcies, scandals and blowups stemming from the late 1990s bubble economy, the Standard & Poor's 500's P/E is still sharply higher than it has been for most of the last 100 years.
While current stock prices might seem cheap compared with their former highs, the truth is that on a historical basis, equity valuation is still stuck in the stratosphere. And stocks aren't expensive only when compared with earnings. They're also quite pricey when compared with other asset classes, particularly hard assets and commodities.
We first started writing about hard assets back when gold was at $275 an ounce and most commentators were still picking bottoms on the QQQ. Although hard assets as an asset class have solidly outperformed equities in recent years, value players should note that on a comparative basis, they're still relatively cheap. Just as we compare a stock's price to its earnings, we can contrast the Dow Jones Industrial Average to any number of commodity-related indicators to illustrate their relative value.
For example, consider gold. We last wrote about the Dow/Gold ratio just over a year ago, with gold at $320, roughly 12% lower than its current spot price of approximately $360. And even though the metal's price has risen, the ratio compared with the Dow hasn't changed much. Right now, the dollar value of approximately 26 ounces of gold equals the number of points on the Dow. For most of the past century, the ratio has rarely exceeded 20.
See the chart below.
A similar conclusion can be found by comparing the Dow with another precious metal, silver. The Dow/Silver ratio, calculated by dividing the Dow by the current spot price of silver, sits near 1,880. But from 1914 through the early 1990s, the ratio never exceeded 1,000 and rarely broke 800. If you believe in buying on the cheap, then it's silver, not stocks, that's the real bargain in today's market environment.
Of course, there's more to hard assets than simply precious metals. When we broaden our scope to include commodities like pork bellies, wheat and natural gas, the relative overvaluation of equities becomes even more apparent. Comparing the Commodity Research Bureau (CRB) index to the Dow, one finds the ratio is still at an historically overvalued level. Now resting near 38, it's only since the early 1990s that the ratio consistently traded over 10.
Hard assets aren't just comparatively cheap; they're technically strong, with many markets testing multidecade highs. But as we pointed out earlier this summer, the trend has continued largely unnoticed by the mainstream press.
Although some of us indeed have gold bars stashed in safety deposit boxes, you haven't had to go that far to benefit from higher commodity prices. The two hard asset funds we've profiled, Oppenheimer Real Asset and Van Eck Global Hard Assets, are up approximately 30% since first mentioned less than two years back.
Look folks, I'm not a permabear, nor am I a pessimist. I'm merely a student of history. And although big moves take time, most historical relationships eventually revert to the mean. So forget the headlines about terrorism, the Saudis, blackouts, supply shortages and nuclear holocaust. The most compelling argument for hard assets is also the simplest: They're cheap.
Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC>