Who Foresaw the Collapse in 2008
January 20, 2009
Tom Au is Chief Economist with the Wentworth China Fund, a NY-based investment advisor, and author of A Modern Approach to Graham and Dodd Investing. He also writes for TheStreet.com, the Prudent Bear, and other investment newsletters. Mr. Au graduated cum laude, with a B.A. in Economics and History, from Yale University, and an M.B.A. in Finance from New York University. He is a Chartered Financial Analyst (CFA).
We spoke with Tom Au on January 13, 2009. Our previous interview with him was on April 3 2008.
At the end of last year, you forecast a 50% correction in the market. You were a lot more accurate than most, so we’d like to know where you stand for 2009.
I first made that forecast in October of 2007, when the Dow was at 13,000 and the market was overvalued by a factor of two-to-one. I believed then, as I do now, that a fair valuation is around 6,600. We are still overvalued.
The good news is that this is an estimate, and the margin of error is plus-or-minus 50 percent. The fair value is between 3,300 and 9,900 and we are within that band. In October of 2007, as well as at the beginning of last year, we were not within that band.
The market is no longer crazily overvalued like it was a year ago.
The market will go down in 2009 for two reasons. First, we are still above the mid-point of the band. Second, post-election years are typically down. More to the point, there has been a change of party within the presidency, as was the case in 2001. New policies will take time before they have an effect. This argues strongly for a bear market.
What other insights does your valuation model offer?
Dividends are under pressure. In theory, this should increase book value and make stocks more attractive for value-oriented investors. The so-called investment value model we use for valuation is book value plus ten-times dividends. With dividend cuts looming, this raises questions about stock values.
We are in the second stage of the market downturn. The first stage was the correction which brought the market closer to its fair value. In a typical correction situation like this, the market goes to a level that is 15% over fair value. The second stage is the earnings collapse, like we just saw with Alcoa. [Ed. Note: Last week Alcoa announced a series of layoffs and programs to reduce spending. Yesterday, it announced a $1.19 billion loss for the fourth quarter of 2008.]
There will be further corrections – not due to overvaluation, but rather due to earnings disappointments.Display article as PDF for printing.
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