Stocks: It's Not When to Get in, But How

June 20, 2013— -- At a recent investing seminar I conducted, a gentleman voiced a concern that is common in the current high-flying stock market: He didn't want to invest in stocks until after a major correction — after the market falls substantially.

His skittishness is understandable. It's never a matter of whether a bull market will correct, but of when. Millions of investors got hurt badly by paying up for stocks in 2007 and 2008, only to lose value in the market meltdown of 2008–2009. Now, many of these same individuals are sitting on the sidelines, looking for a good time to get back in. To them, the current market ascendance is a warning sign to wait for a correction so they can get back in at low prices and ride the next uptrend.

One problem with this thinking is that, just because the market crashes, this doesn't mean that stocks will necessarily be a good buy soon afterward. It's not just whether their prices go down; the point is to assess their potential to go up based on what's happening now.

Trying to predict the top of a rising market is a fool's game. For example, take the bull market that started in the mid-1990s and ran until it corrected in 2000. Anyone sitting on their cash during this period missed out on substantial gains. And those who perennially shorted the market from 1994 to 2000, betting that it would soon correct, took a bath every year for several years.

Yale economist Robert Shiller published a book in the 1990s titled "Irrational Exuberance" (borrowing the phrase from then Fed Chairman Alan Greenspan), expressing concern that the go-go stock market at the time might soon be headed for a fall. Since then, the phrase has become a classic moniker for bubble-prone markets. Well, there's an old Wall Street saying about the perils of anticipating corrections that are nowhere near: "The market can remain irrational longer than you can remain solvent."

Investors seeking to glom on to growth might consider what price/earnings ratios (a stock's current price divided by its earnings – a fundamental measure of value) suggest about the relative longevity of the current market. Historically low average P/E ratios might indicate room for growth.

Since 1900, the US equity P/E ratio has averaged around 15, which is about where it stood at the end of 1994. Over the next six years, as the roaring bull market fueled day-trading and speculation, the average P/E ratio doubled. It climbed as high as 46.50 by 2001 before the market crashed.

Investors, motivated by visions of sudden wealth, poured money into dotcom stocks that had no earnings whatsoever. Thus grew the tech bubble.

When the Internet music stopped, people like the gentlemen at my seminar didn't have a chair to sit in, and they lost big time. Those memories might prevent them from investing in this or any market. However, the P/E ratio for the Dow the middle of this month was about 16— not terribly fearsome, considering that companies now are leaner and can borrow money cheaply.

This cheap money seems to help propel profits and boost earnings, thus driving the overall market. That doesn't mean that the market will ascend without some corrections along the way, but comparing this market to the 90's doesn't make sense because of substantially different factors.