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No. of Recommendations: 2
It seems to me that a fundamental change has occured. The impact of hedge funds collapse could be huge over the long term. It is these funds that played a significant role in the rise of stock market over the last 3 decades. With the collapse of these funds and investment banks across EU and US, there will be a huge void left in terms of buyers of stocks. A section of market seems to have permanently disapperared. Stock valuations could stay much lower over the next 2 decades. A P/E of <20 that used to be attractive could be replaced by single digit P/Es. In fact, till 70s, most markets operated in single digit P/Es. The economy can still be good with a much lower stock valuations.

If the above picture is correct then those of us who invested since 1995 would forever be stuck with anemic returns after having financed the pockets of CEOs and realtors and now the banks.

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Personally, I don't think it's so fundamental. A credit bubble popped. There is going to be a lot of deleveraging for a while. Equities may be undervalued by historic standards for a while, but eventually they will revert to the mean.

Fortunately valuations are anchored to economic realities. Stock with P/Es in single digits are producing an earnings yield of >10%. The risk-free rate of return is what, 3%? In times of panic, people demand a big risk premium. But eventually people say, "Wait, why should I settle for a 3% return when this business over here is returning 10%? I've done my homework and I think there is a high likelihood that not only will it continue to generate this level of earnings, but those earnings will even increase." Oversimplified, but the point is that businesses have real value because they make real profits.

I agree we may have a period of low P/Es as investors continue to have an aversion to risk. But as long as interest rates don't take off, eventually the P/E's will become rational again. May take a while, but it will happen.

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The problem I am pointing to is disappearing of a market segment in the form of many hedge funds, banks and investment brokerages. With permanent evaporation of certain buyers stock prices will trade very low for extended periods. Even in the tech crash this class did not disappear. It did disappear in 1932 for several decades.

Why do you think stocks used to trade at low P/E prior to 1970? Why is it that emerging markets had such low P/E for so long. Once the intitutional investors ended share markets surged. These institutional investors are critical for creating demand for stocks and high share prices.

These institutions take decades to rebuild. That is why I call it a tectonic shift.

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Anurag -

Here's the problem with the idea of the disappearance of hedge funds...
Most people in the US use mutual fund/investment funds for their retirement portfolios. The problems of the pension plans and social security are well known - consider the drastic cuts of pensions in airline and auto sectors and the enormous government tax & expense in running the social security program.

I realize that this election along with the collapse of many 401k retirement accounts will prompt government action after the election. The question is whether or not they will stay with the 401k, stock market model.

In my opinion, the government will not be able to create any kind of drastic switch - unless Obama gets in with a democrat house & senate causing frightening new levels of government expansion.

Politics aside, the retirement account money needs to go somewhere, and I don't think it will settle for the long term in low-yield safe havens, especially when inflation begins to rear its ugly head once again. The average person still has control of where the bulk of his own retirement goes in this country, and many will settle for the advice of the mutual fund/401k managers in the long term - which will keep the big institutional investors alive. As for Hedge funds in particular, I don't think they'll disappear as an industry when there are still some with amazing performance such as Soros with his heavy shorting and the incredible liquidity of Buffet.

The future will not revert to the past ... we have the internet with a vast array of knowledge available to the common public, stock trading online, etc... the information age will continue on and people will adjust to something that makes sense in the current age. With the markets of today I seriously don't think it will be long-term single-digit PE's.

Hence, I will keep even my low- or no-yield growth stocks such as MPEL, GIGM, CBI, SLT, GSI, KHD, etc rather than dumping them for the current high-yield bargains. New cash will go to the high-yield bargains while they last, however. And yes, I am seriously thinking of borrowing to invest in stocks of strong, steady companies giving high yields - fortunately, however, I have a little cash left to buy with. The market crash may be quite a bit deeper, but that won't change the fundamental value of a high-yield stock in a steady industry with a safe dividend such as utilities, fast-food, discount retailers, cola or beer companies or other such giants that won't die out in a market slump.

The future is far from certain, best of luck in whatever strategy you choose.

-John T
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"The future is far from certain, best of luck in whatever strategy you choose."

Players come and go. Tectonic shift or not, my strategy remains the same - "Buy Low Sell High".
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