It was 1999 when the Standard & Poor’s 500 Index first hit 1,300. However, in 1999, the Federal Funds Rate was set at 5%, and S&P company earnings were averaging $47. In comparison, today, the S&P is just below 1,300 with a Fed Funds Rate at 0% and company earnings average $90. Today, the market is cheap. We are seeing fixed investments that are grossly overpriced and a stock market that is—at worst—slightly undervalued.
The reason we buy stocks is to generate cash flow and earn a profit.
- If you had purchased The Coca-Cola Company (NYSE: KO) in 1999, the stock has since more than doubled its profits.
- Many stocks pay an income stream well more than gold.
- Currently capital is cheap and company profits are high.
- Stocks are trading at a P/E ratio that is significantly less than the peak and below their average.
- If earnings remain constant, but the price per share continues to rise the P/E will be higher. At some point, the stock will be deemed “expensive.”
- Conversely, as the P/E falls, the stocks become “cheap.”
The price of gold can likely be attributed to the perception that it is a global currency. When people want a hard currency, they turn to gold.
- If you truly believe the dollar will go to zero, and Armageddon is coming, gold is not the place to be.
- With the natural disaster in Japan, the people do not want gold.
- They want food and water.
- While gold may hold more value in case of inflation, the price is more likely a bubble.
A note on the historic performance of gold.
- From 1975 through 1980, gold outperformed The S&P 500 by more than 19% annually, and recently—2005 through 2010—by more than 20% annually.
- However, in the 20 year span between 1980 through 2000, gold fell by 53.84% (-3.79% annually), while inflation (measured by CPI) rose 102.08% (3.58% annually) and the S&P 500 increased by approximately 1,737% (15.66% annually).
- In all, gold has appreciated by 6.78% annually since the end of 1975 while the S&P 500 has appreciated 11.29% annually on average and inflation has marked a 4% annual increase on average.
What about inflation?
- We believe the S&P 500 and stocks, in general, provide a better hedge against inflation in the long run. This is because companies have the ability to pass the inflationary prices of their inputs along to their customers thereby growing earnings by an amount in excess of inflation.
- Gold has no earnings and can only trade relative to the value of other assets (or currencies); therefore, it should not be expected to outperform inflation over long periods.
- Any time gold outperforms equity asset classes, we would be suspicious that the shiny metal has experienced what is commonly known as overshooting, whereby its price has moved correctly in anticipation of inflation, but momentum has carried the price beyond its intrinsic long-term value.