Does crisis and war create a buying Opportunity? (page 1 of 2)

They correctly point to Pearl Harbor, the Cuban Missile crisis, the J.F.K. assassination, the 1973 oil embargo, the Nixon resignation, the 1987 stock market crash, the Gulf War ultimatum and the LTCM crisis, and so on. Here you would already have made money after a six to 12 months holding period.

In particular Pearl Harbor has been widely mentioned as an example that a military setback or a war provides a great entry point into equities. However, I should just like to highlight some key differences between Pearl Harbor in 1941 and the September 11, 2001 attacks.

When the American Fleet was attacked at Pearl Harbor on December 6, 1941, the US stock market was at one of its most, if not the most depressed level in the 20 century. The American stock market capitalization as a percentage of GDP amounted to just 21% - an all time record low - compared to presently approximately 120% (down from 184% in March 2000).

Shortly before the attack on Pearl Harbor, the Dow Jones sold around 115 (the 1941 trading range for the Dow Jones was 133.6 to 106.3). The Dow was down from a high of 381.1 in 1929 and 194.4 in 1937. In other words, the Dow was 12 years after its 1929 high still down by 70%. Over the same period of time, the Dow Jones' earnings per share had fallen to $11.6 down from a high of $19.9 in 1929.

Moreover, at its December 1941 low the Dow Jones sold for less than its book value and it had a dividend yield of 6.2%, and a P/E ratio of 10.5 on depressed earnings. Then let us briefly look at the earnings yield bond yield ratio and the dividend bond yield ratio, both indicators, which are now widely used by strategists to foster their bullish case.

In 1941, long-term government bonds yielded between a low of 1.85% and a high of 2.10%. Prime corporate bond yields averaged 2.56%. Thus, the Dow Jones had a dividend yield of more than three times the yield of long-term government bonds. Also, after the attack on Pearl Harbor the Dow Jones' earnings yield reached more than 10% - that was more than 5 times higher than the long-term government bond yields!

By comparison, at present, long-term government bonds yield three times more than the S&P 500 dividend yield and also exceed its earnings yield, possibly by far more than strategists seem to think, if earnings do not recover!

Thus, I feel that the comparison between Pearl Harbor in 1941 and the September 11, 2001 attack is rather far fetched. In fact if we compare bond yields and dividend yields of the stock market in the US since 1871, we note that the maximum gap of stocks yielding more than bonds was reached in 1941, whereas a maximum gap of bonds yielding more than equities was reached in 2000.

The 1940s represented from a longer-term perspective the very best buying opportunity for US stocks. This was so, because growth expectations were extremely low, which explains why investors had a preference for the safety of much lower bond yields over the 'uncertain' dividends paid out by equities.

The mirror image, however, occurred in 2000. Never before was the gap between bond yield and dividend yield wider, indicating 'euphoric' expectations by investors about future economic and corporate profit growth. Thus, the way the 1941 provided a lifetime buying opportunity for US stocks, future financial history books may regard the years 2000/2001 as having provided a lifetime opportunity to liquidate US equities.

If any comparison ought to be made between 1941 and 2001, it ought to relate to the US bond market.