The Hidden Reason Why Stocks Are Expensive (Justin Spittler)

Originally Published by Casey Research

Did you lose money in stocks this year?

On Friday, the Dow Jones Industrial Average hit a two-month low. It fell 2.1% to its lowest level since October.

Meanwhile, the S&P 500 fell 1.8%. Financial stocks fell the hardest, dropping 2.5%.

• Dispatch readers know U.S. stocks have been in a bull market for almost seven years…

The S&P 500 climbed 204% from March 2009 through December 2014. But the bull market has stalled out this year. The S&P 500 is down 2.6% in 2015.

In September, E.B. Tucker, editor of The Casey Report, said the bull market died in August. So far, his call is spot-on. None of the major U.S. stock indices have hit new highs since July.

Unless stocks rally in the next two weeks, 2015 will be the S&P’s first losing year since 2008.

• However, U.S stocks have gotten more expensive this year…

In January, the S&P 500 had a price/earnings (PE) ratio of 20. Now its PE ratio is 21.2. A higher PE ratio means stocks are more expensive.

At first, this might seem impossible. Stock prices have gone down this year…shouldn’t stocks be less expensive?

Stocks can get more expensive in two ways. Prices can go up…or earnings can go down. This year, earnings went down...

• Second-quarter earnings fell 0.7% from last year…

And third-quarter earnings fell 1.5% from last year. Wall Street widely expects the S&P 500’s fourth-quarter earnings to fall 4.5% from last year, according to research firm Fact Set.

If that happens, it will be the first time since 2009 that the S&P earnings dropped three straight quarters.

• Dispatch readers know a few huge, expensive stocks are propping up the S&P 500…

As we just mentioned, the S&P 500 is down 2.6% this year. Yet the average stock in the S&P 500 is down 5.0%, or almost twice as much. This is happening because big stocks move the S&P 500 much more than small stocks…

Take Google (GOOG), for example. It’s the second-largest company in the S&P 500. Google is up 43% this year. It’s also very expensive, with a PE ratio of 35.6.

Amazon (AMZN) is another example. It’s the fifth-largest company in the S&P. Amazon is up 114% on the year. It also has an astronomical PE ratio of 963.

Historically, the S&P 500 has had an average PE ratio of 15.6. With a PE ratio of 21.2 today, the S&P is now 36% more expensive than average.

• Bull markets don’t end just because stocks are expensive…

However, all bull markets end eventually. And when stocks are expensive, they have more room to fall when a bear market takes hold. Like the old saying goes, “the bigger they are, the harder they fall.”

For example, during the dot-com bubble in the late ‘90s, the S&P 500’s PE ratio peaked at a sky-high 34. It went on to plunge 48%.

We think the bull market in stocks has already topped out. To protect your money, we recommend keeping a significant amount of your wealth in cash and physical gold. You may also want to “hedge” your portfolio by shorting (betting against) stocks likely to crash the hardest during the next big selloff.

Good short candidates include very expensive stocks…and companies that would struggle to make money in a long economic slowdown.

• Moving along, Brazil’s economic crisis is getting worse…

Casey readers know Brazil is in a severe economic meltdown…

Wall Street is watching Brazil with intense interest. It’s the world’s fifth most populous country. It has tremendous natural resource wealth. It’s the “B” in the popular Wall Street acronym “BRICs,” which stands for Brazil, Russia, India, and China. These are the four largest emerging economies. They all have huge growth potential.

That said, Brazil’s GDP shrunk 4.5% in the third quarter…its worst quarter since Brazil began tracking GDP in 1996.

Meanwhile, Brazil’s currency, the real, has plunged 32% against the U.S. dollar this year. And the iShares MSCI Brazil Capped ETF (EWZ), which tracks Brazil’s stock market, has plunged 42%. EWZ is now trading at its lowest level since January 2005.

• Collapsing commodity prices have crushed Brazil…

Brazil’s economy depends on commodity exports. For example, Brazil is the world’s second-largest exporter of iron ore, the main ingredient in steel. Iron ore is, by far, Brazil’s largest export. The price of iron has fallen 49% over the past 18 months.

Meanwhile, the price of soybeans, Brazil’s second-largest export, has plunged 37%. Soybeans are now trading at a five-year low.

And the price of oil, Brazil’s third-largest export, has crashed 66% since June 2014. Oil is now trading at a six-year low.

• Last week, credit rating agency Fitch downgraded Brazil’s government bonds to “junk” status…

This means Fitch thinks there’s a significant risk that Brazil won’t pay back its debt. Fitch expects Brazil’s economy to shrink 3.7% this year and another 2.5% in 2016.

The Brazilian real has fallen 2.4% against the U.S. dollar since the downgrade.

• Fitch is the second major credit agency to downgrade Brazil’s bonds to junk status this year…

Standard & Poor’s (S&P) did the same thing in September.

Moody’s also downgraded Brazil’s credit rating last week. It currently rates Brazil’s bonds one notch above junk status. Moody’s said it would cut Brazil’s rating to junk if the country’s financial situation doesn’t improve.

• Nick Giambruno, editor of Crisis Speculator, says the downgrades are a major blow to Brazil’s economy…

Here’s Nick:

After decades of financial volatility, Brazil earned its coveted investment-grade rating in 2008. This solidified Brazil’s status as an emerging economic power. And that’s why the recent downgrades by Fitch and S&P are such crushing blows to Brazil’s economy.

Many investment managers can only invest in investment-grade securities. When a credit agency downgrades a country’s debt to junk status, it can force huge funds to pull money out of that country.

• Nick uses the same investing strategy as Casey Research founder Doug Casey…

He buys assets in beaten-down countries that other investors are too afraid to buy. Often, you can buy a dollar’s worth of assets for pennies in these crisis markets.

In the October issue of Crisis Speculator, Nick told subscribers about a world-class Brazilian company that should continue to make money even if Brazil’s economic crisis gets worse. It’s already a bargain, and Nick thinks it could get even cheaper.

I’m waiting on a catalyst that will thrust Brazil onto the front pages of First World newspapers…something that gets Wall Street to say “sell anything Brazilian.”

When the blood really starts flowing in the streets – and that could be soon – it will be the best time to pull the trigger.

Whatever the catalyst ends up being, the impending crisis in Brazil will likely give us a chance to pick up shares of a blue-chip company at bargain basement prices.

You can learn about this company by trying out Nick’s investment advisory, Crisis Speculator. Click here to start your risk-free trial.

Chart of the Day

Brazilian stocks have plummeted…

Today’s chart shows the performance of iShares MSCI Brazil Capped ETF (EWZ) over the past five years.

EWZ hit a post-financial crisis high in April 2011. The Bloomberg Commodity Index, which tracks 22 different commodities, also peaked that month. Commodity prices and Brazilian stocks have both been falling ever since.

The Bloomberg Commodity Index has dropped 56% from its April 2011 high. Meanwhile, EWZ has dropped 73%. That includes an incredible 42% drop this year.

The article The Hidden Reason Why Stocks Are Expensive was originally published at caseyresearch.com.

View the Casey Research Guide to Crisis Investing on InformedTrades

The Hidden Reason Why Stocks Are Expensive (Justin Spittler)