Over the past few weeks, an increasing number of equity investors began to question President Barack Obama’s socialistic agenda and the potentially negative effects of his spending and tax proposals on the economy. As a result of those concerns, stock prices have fallen sharply since Obama was sworn into the office of the Presidency on Jan. 20.
However, there’s a bright side to the recent downturn in equities — stocks are now trading at ridiculously low prices relative to their companies’ cash flows, net asset values, and future earnings capacity.
Although some investment commentators point out that stocks fell even further than their current valuation levels during the early 1930s, there’s a big difference between the current economic environment and the economic situation during the depression era of the 1930s.
For example, industrial production declined 45 percent during the early ’30s, yet that coincident economic indicator is currently down only 10 percent from a year ago.
In regards to the employment situation, approximately 25 percent of working-age adults were unemployed during the Great Depression. In contrast, only 8.1 percent of U.S. citizens over the age of 16 are currently unemployed.
Some other statistics that reveal the substantial difference between the current recession and the depression of the 1930s include consumer spending, personal income, and real gross domestic product.
For example, during the early 1930s consumer spending declined 10 percent, personal incomes fell 40 percent, and real GDP declined a whopping 30 percent. In contrast, consumer spending is declined only 2 percent this past January, as compared to the same month a year ago, while personal incomes actually rose 1.9 percent.
In regard to the overall economy, real GDP fell a very modest 0.8 percent during the fourth quarter of 2008, as compared to the same period a year ago.
Although my models indicate that the economy will remain weak during the months ahead, those same models indicate that economic conditions will improve during the second half of this year and that real GDP will rise substantially.
Meanwhile, stocks and equity ETFS are currently trading at ridiculously low prices in terms of their future earnings capacity.
For example, the iShares FTSE/Xinhua China 25 Index Fund (FXI) had a PEG ratio of only 0.83 when I last reviewed all of its holdings on Feb. 10. Given that the price of that ETF has declined 11 percent from February 10 to March 9, its PEG ratio is probably now around 0.75.
If you’re not familiar with the PEG ratio, that statistic compares a security’s market price to the future earnings capacity of the security’s related holdings. Specifically, the PEG ratio compares a security’s price-to-earnings ratio to the projected growth rate in the earnings of the underlying companies’ earnings over the next three to five years.
Securities with a PEG ratio of less than 1.0 are considered to be good values —underpriced by market participants — because the prices of those securities are less than the estimated growth rate of earnings.
Hence, FXI is currently trading at a bargain price, since its PEG ratio is substantially below 1.0.
My models indicate that the Chinese economy will continue to grow at a rapid rate over the coming years. FXI holds a broad group of securities in the telecommunications, energy, financial and industrial sectors. I therefore strongly encourage equity investors take a look at FXI.
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