Take stock and put your money on the metals

US stocks might now have bounced off their lows of last month but they have only retreated to the fair value levels last seen in 1991. Typically stock markets tend to over-correct, so that would suggest that we are not at the bottom yet, although it might not be that far away.

Warren Buffett's great mentor Benjamin Graham looked at stock prices against their 10-year average earnings per share to gauge value. On that reckoning stock prices are only slightly cheaper than their long-term average for the first time since 1991. Stocks have been overvalued for a very long time.

This warning is not new. Warren Buffett made it in his 1999 Sun Valley presentation to the US business elite, which is in the opening chapter of the new Buffet biography. But it does conflict with his recent advice to buy US stocks.

Could a long period of sub-average valuations follow for stocks? Perhaps but we clearly still have to find a bottom in stock prices first. They always over-correct on the way down, a reverse of the irrational exuberance of the upside.

How long will that take? The most optimistic point to spring next year but increasingly experts suggest the middle of next year might be the time to buy, presumably after people 'Sell in May and go away' as the old adage suggests.

To support the Graham analysis you can also turn to James Tobin's q-theory. This considers the market capitalisation of a company compared to the net worth of its assets. But again we sadly only arrive at the fair value position, and there is no buying signal from q-theory.

In short, at this stage any rallies in stock markets should be seen as selling opportunities, if by mischance you still have US equity investments – and by implication most global stock markets like the UAE will also follow this trend so lighten up there as well.

How far US economic policy will offset the depression forces in place is the big call for 2009. The 37 per cent fall in US auto sales last month was bad news this week. But it is notable that at least global economic policy is different from the 1930s. Whether it will work is another thing.

Could gold and silver stocks be the exception to this down wave? Veteran analyst Dr Marc Faber thinks so. That was the experience of the 1930s and a coming dollar collapse would likely be the backdrop for a repeat performance by the precious metals sector.