Sunday, March 04, 2007

What's going on?:

The markets have been pretty jittery of late, losing about 5% over the last week. What should we as investors make of this? Well for one, not much has changed. The markets still at 20 times earnings and 3.6 times book value, implying that companies have been generating great returns on equity. Unsustainable returns, in fact. Throughout history, the magic number for corporate returns on equity has been 12%. Throughout every period, regardless of even inflation, 12% has been the average and the range has been fairly narrow. (see article) We are now at over 20% due to several factors. One has been lower labor costs due to globalization, which has fattened profit margins. The other has been cheaper and more leverage. None of these lead to sustainable higher returns on equity however. A majority of the SnP 500 companies are still commodity companies with little real moats, and as yields continue to get lower everywhere else, they will eventually flood directly to capital investments. People forget that things do get worse, that market cycles are inevitable, and they push stock prices to unjustifiably high levels. So dont expect me to be jumping in to buy anytime soon even with my huge cash position. Things can get a lot worse.

" Q: What do you see as the biggest threat to economic recovery in the

John Templeton: We don't need an economic recovery because we're already operating
at a very high level. The greatest threat to maintaining this level of
economic activity is debt. There's never been a time when people
worldwide, and especially in America, had such a high proportion of
debt. I think 20 percent of people who have mortgages on their homes
are likely to lose them in foreclosures. When a home goes into
bankruptcy, it's sold at auction. That pushes the price down and
affects the prices of other homes."

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