This Week in Stock Market History - 3 Lessons From The Past

“There is no better teacher than history in determining the future... There are answers worth billions of dollars in a $30 history book.”

― Charles T. Munger, in Poor Charlie’s Almanack

1) September 29th, 2008 - Markets plummet on failure to pass bailout package

Many of the significant headlines that crossed the tape earlier this week centered around rumors of additional government stimulus spending. The market moved several percent on a single headline about Nancy Pelosi and Tim Mnuchin in talks.

This kind of volatility around government action (or inaction) is hardly new. Our previous financial crisis saw the same focus on government stimulus this week 12 years ago, just one day after Wachovia Bank failed.

On that day, the failure of a bill to provide support to struggling banks failed to pass Congress and resulted in a decline of nearly 7% in the market, and the largest single-day point decline in the Dow Jones Industrial Average's history.

Now jump back to the present day. Much of the market's rise has been due to government stimulus and perceived stimulus in the future. If we get any surprises in the next few weeks or months, you should be prepared for similar volatility to resume.

In 2008 it was banks and insurance companies, today it is airlines, cruise lines, and other hospitality companies. If you are heavily invested in any of these, the lessons of how finance companies weathered the mortgage crisis needs to be fresh in your minds.

Unlike in the current crisis, Buffett was famous for making billions of dollars in investments as the mortgage crisis unfolded. In one week in 2008 he invested $5 billion in Goldman Sachs, and then $3 billion in GE.

Years after the financial crisis, everyone called Buffett a genius for these investments. But, what many people forget is that at the time of his purchase, common shares of GE were at $20 per share. They would fall below $7 in March 2009.

What seemed like a genius investment (and one that would net Buffett billions in profits) years later, looked like a colossal mistake for the first 6 months after his purchase.

President Trump's positive coronavirus test was enough to send stock markets falling Friday. While we will have to wait to see how the situation develops, we should expect any updates to have big impact to the markets.

Trump is hardly the first president to fall ill while as president. This week 101 years ago also saw another one of our presidents hospitalized. Woodrow Wilson (who also was infected by the 1918 flu), suffered a massive stroke. The stock market fell 2% immediately, but the decline continued for the next 3 months and lead to a 20% total drop.

Will we see a similar drop today? Only time will tell...

Weekly Wisdom

Using Enterprise Value Instead of Market Cap to Determine if a Company is Cheap or Expensive.

What first comes to your mind when you think of a "cheap" - or value - stock?

If you are like most, a low P/E Ratio came to mind.

But depending on the capitalization structure of the company you are looking at, that could be a big mistake thinking a low PE ratio = cheap stock.

Take for example AerCap Holdings (Ticker: AER):

(And before you think this is just because of the pandemic and a drop in earnings recently, even if you look at the company's forward PE ratio based on analyst estimates, it stays below 5 through 2021.)

Value investors today salivate over a company with a PE Ratio like this. But what is this not telling us?

The company's (massive) debt.

And this is why many investors like to use Enterprise Value instead of market cap when valuing stocks. Enterprise value adds the company's debt balance to the company's market cap, and gives a truer sense of the real cost for a buyer.

As you can see, the company's PE ratio looks small because of its relatively small $3.4B market cap. But when you factor in the company's near $31 billion in debt, its Enterprise Value jumps to $32 billion - Nearly 10x its market cap!

Now, those cash flows don't seem nearly as cheap!

PE Ratios can still be useful. But make sure you are comparing companies with similar capitalization structures. If one is equity based and another debt based, comparing their P/E Ratios is pointless, and you may have more luck using Enterprise Value instead.

We give a more thorough explanation, with more examples in our article here:

Enterprise Value – What is it and How to Calculate EV

What We Are Reading This Week

What Does a Bond Bear Market Really Look Like?

Unless you have been investing for more than 40 years, you have not experienced a true bear market in bonds. The topic of what a bear market in bonds looks like his a big one in the investment advisor community. Will bonds continue to play an effective role in portfolios even with such low interest rates?

My company recently hosted a webinar for clients where we took a look at a bond's role in a retiree's portfolio today. There is an upload on youtube here. It is on the longer side, and touches many different aspects related to bonds, but we do eventually get to what bond returns might look like in the future.

(Podcast) Animal Spirits - A Random Walk with Burton Malkiel

I have always enjoyed the animal spirits podcast and Michael and Ben's views on the current state of the markets. In this episode they interview one of Wall Street's earliest adopters of index funds - Burton Malkiel.

Malkiel's insight is unmatched. This episode, and his famous book A Random Walk Down Wall Street, should be required reading for any investor.

Our YouTube channel is full of videos on stock market history, how-to videos, product and book reviews, and more!

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