When those March tornadoes devastated stock market prices somebody asked how far stocks can drop before hitting rock bottom.
Those were the weeks when This Scribbler’s comfort theory blew up. In previous stock downturns you could take comfort, in fact joke, that if the market kept dropping like this every day in a few months it would hit zero.
The idea: markets never get to zero.
The March storm was too close for comfort. At one point this comfort theory calculated twelve more days like that and the market would hit zero.
So, how far can stocks fall before they bottom? Many market observers believe the current virus-driven fall will drop a second shoe on investors.
Likely, that will happen once data shows how badly the economy suffered. We should know that by the end of July. Previous huge stock falls have often occurred in the last week of July.
The hockey stick rise in stocks since the 2008-09 financial crisis was only partially driven by increased value.
Most of that drive to higher and higher highs was driven by easy money — central banks flooding us with cheap interest on money.
Computer trading accelerated the upswing, and the downswing when it came. Companies buying back their stock to prop up prices was a factor.
Investors, dissatisfied with low interest on fixed income, helped drive up prices of dividend paying stocks, and will likely continue that path.
There is a rule of thumb in valuing stocks that says the ratio of price to earnings should be 20 minus the rate of consumer inflation. With two per cent inflation the price earnings ratio should average 18 times.
Investors played that rule when they drove up prices to obtain better dividend yields than the paltry interest on savings. Many of these folks have little or no knowledge of the market’s casino-like behaviour.
Let’s examine some companies to see the point. Start by realizing that in normal times — pre-2008 — stocks of most companies often traded between eight and 12 times the earnings.
Telecommunications leader BCE is known as a widows and orphan holding for its stability, safety of dividend and regular dividend increases.
At the high BCE was trading at 19 times earnings but still paying a dividend yielding 3.8 per cent. The yield hunters drove the price.
As of this writing, stodgy old BCE trades at $57.27 and yields 5.77 per cent.
Under “normal’’ trading conditions, BCE would trade between $27 and $40 — between eight- and 12-times earnings.
If the other viral shoe drops that is where the price could, in theory, drop.
Let’s look at AltaGas, currently $14.25 and yielding 6.8 per cent. At the high AltaGas, now mostly a utility stock with a propane LNG plant on the West Coast, traded at $22.74 and a reasonable 8.2 times earnings.
Now the shares trade at five times earnings, an indication rock bottom is here.
At $74.89, Bank of Montreal trades at 8.2 times earnings, with dividend yield of 5.8 per cent — indicating a near low.
At the high of $106.52 BMO traded at 12 times earnings and yielded 3.9 per cent.
Depending on the price earnings ratio some stocks could fall further. In a panic selloff there is no floor price. Most analysts believe market lows will be tested yet this year.
CAUTION: Remember when investing, consult your adviser and do your homework before buying any security. Bizworld does not recommend investments.
Ron Walter can be reached at [email protected]
The views and opinions expressed in this article are those of the author, and do not necessarily reflect the position of this publication.
