Is it time to get back into the market?

Fear index shows its time to buy
By David Uren November 17, 2008 12:00am

Some experts are saying its time to get back into the market
But more economic pain is in store

Markets: The latest trading news and share prices
AFTER each thumping day of share market falls, a few hopeful investors open their wallets and, following Warren Buffett's dictum to "be greedy when others are fearful'', buy a few stocks.
Often as not, they are thumped again the next day, but sooner or later, the wisdom of hindsight will illuminate their vision, The Australian reports.

If you accept the latest economic forecasts from either Treasury, or the more pessimistic ones from the Reserve Bank, the time to buy is now. An outlook in which the economy slows this year and next to somewhere between 1.5 to 2.25 per cent before rising back above 3 per cent in 2010-11 will soon reveal that stocks have been over-sold.

These forecasts imply little growth in profit, but no great falls over the next 18 months or so, with a return to robust growth thereafter. It is the uncertainty around those growth forecasts that is the problem.

Since the beginning of this year, every time anyone revisits their economic forecasts, they have been revising them down.

There was barely four weeks between the last two sets of downward revisions by the International Monetary Fund and then only a week before the OECD put out some even more pessimistic numbers.

So far, all Australia has seen is a lot of market action that has made people nervous. Shares have plunged, and the less visible money markets have been volatile beyond precedent.

That market punishment has been stretched out over the better part of a year, but there has been little real economic fallout, at least in this country.

Treasury secretary Ken Henry could put the telescope to his eye last week and, looking backwards at the 4.3 per cent unemployment rate and 11 per cent growth in gross company profits in the June quarter, declare that Australia had little to fear from the economic squalls ahead.

The Reserve Bank, which has long been a fan of equities, published the first chart in its quarterly economic review last week, showing that the share market has now taken values far below their long-term average relationship with profits. This is so, whether the comparison is with historic earnings or analysts' projections of future profits.

The second chart, prepared by University of California professor James Hamilton, makes the same point for the United States market, but over a 130 year time span.

He says the academic literature has established that the ratios of price to earnings and dividends to earnings do not wander too far from their long-term historical averages.

"The implication of that finding is that when prices are high relative to dividends and earnings, you can expect below-average stock returns,'' he says, and vice versa.

At present, with price earnings ratios below the long-term average, superior long-term returns are to be won.

A similar point was made recently by the Reserve Bank's deputy governor, Ric Battellino. The prospective earnings yield on Australian shares now stands at 11 per cent, almost double the long-term average.

"When the yield has risen to these levels in the past, the return on shares over the subsequent 10 years has almost always been well above average,'' he says.

The damage to the real economy is coming. We're seeing it around the world as lay-offs mount, industrial production slumps and one economy after another records quarters of contraction.
It is certainly true that the Australian economy has some insulation. It enters the economic downturn with a strong budget surplus and high corporate profitability. The floating exchange rate provides a buffer, and will help to extend the last gasp of the commodities boom.

Some of these strengths may prove ephemeral, however. Profit levels are the most obvious.
Gross profits have reached a record 27.8 per cent of the economy, a long way north of the long-term average of 20.0 per cent.

Read the full article at The Australian.