We are just two weeks into the new year but it feels longer.
On Friday, the S&P 500 was down 2.2% for a total decline this new year of 8.0%. And, Toronto was down 2.1% bringing its decline for the new year to 7.2%.
Many stocks continue to decline despite the fact that they appear to be trading below a reasonable value based on their profits and net assets per share.
In Canada the biggest reason for the decline is the low oil prices.
In the U.S. the decline is partly related to the oil prices and to the low expectations for world growth in 2016. Also the sharply higher U.S. dollar is hurting the earnings forecasts for U.S. multi-national companies.
The Q4 earnings reports have started to be reported in the U.S. and have generally met expectations.
In Canada the energy companies are certain to report poor results. However certain companies that sell into the U.S. market should do well including the forestry sector.
Stantec will suffer on its energy related work but should get a good boost from the dollar on its U.S. work.
Investors wonder how low the market can go. I don’t think anyone knows the answer to that. It could go lower or it could turn around anytime.
The lower market is obviously painful. But for many investors there is at least a silver lining. If cash is available then stocks are on sale. The youngest investors should certainly cheer lower markets since the amount they currently have invested is likely to be small compared to what they will invest in the future, even the near future.
Canadian government bond yields have continued to go lower. The 5 year is at 0.55% and the ten year is at 1.15%.
It seems that the market would prefer to buy a ten year bond that locks in a 1.15% annual yield for ten years rather than take a chance on let’s say Royal Bank which trades at a P/E of 9.75, which translates to an earnings yield of 10.26%. And the dividend yield is 4.53%. One has to be extremely pessimistic to conclude that the Royal Bank shares will not outperform the ten year bond that will, of a certainty, return just 1.15% over its ten year life.
Melcor is trading at 47% of its book value. It is true that Melcor’s earnings could decline precipitously. If home building grinds to a virtual halt in Alberta and if Melcor decides to stop developing new commercial buildings, due to the economy, then its earnings would be very low on an adjusted basis and would be negative on a GAAP basis due to mark-to-market value losses on rental buildings. It would still have some earnings from its rental properties. But Melcor could sit on its land assets and wait for better times. It has a strong balance sheet and can sustain periods of low activity. Its assets are mostly land and buildings. There has been no suggestion that land or commercial buildings in Alberta have declined in value by anything remotely approaching 50%. Melcor represents the opportunity to buy an equity interest in solid land and building assets at a price of less than half the equity that seasoned management team has invested in those assets. In a pessimistic market there is nothing to prevent share owners from continuing to sell the shares at lower prices. But buying an equity interest in these solid assets at half price seems likely to work out well.
The market decline is painful. But we can be certain that the likes of Warren Buffett is out there buying shares rather than worrying about the declines. And he is buying them from investors that have basically been scared out of holding those stocks.