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Advice from the past rings true today

- Alan Lavine and Gail Liberman



If Ben Graham, father of modern security analysis, were alive today, what would he advise investors?

He would probably tell us that overall, the stock market is still overvalued. But there are plenty undervalued stocks.

Based on a Jan. 1, 1972 interview that Graham provided in Forbes, we can learn from his thoughts on how to manage money in crazy times like these. We are in a bear market, yet the economy is growing and stock fundamentals look good.

Graham, who was 77 at the time of the Forbes interview, always recommended that investors keep part of their portfolios in bonds because the stock market was overvalued and being driven up by speculators.

Sound familiar? We just had one of the greatest stock market bubbles burst in March 2000. Over the past 2 1/2 years, the S&P 500 had dropped about 40 percent as of this writing.

The stock market had been up 18 percent annually during the first two years of the 1970s--the period of the Graham interview. The market had made back about half its losses from the devastating 1969 and 1970 crash. In 1972, the market gained 19 percent. The decade of the 1970s saw stock prices rise at a measly 5.8 percent annual rate.

Graham advised taking a mildly active stance in the financial markets. He said to diversify in stocks, bonds and bond equivalents, which are today's modern money funds. The higher the stock market goes, the more you put in bonds. The lower stock prices go, the more you invest in stocks. As a result, you are dollar cost averaging and rebalancing your holdings.

So when did Graham advise taking money out of stocks and putting it into bonds? When stock prices are too high. That happens when the yield of a stock's earnings is less than the rate of high-grade corporate bonds.

The earnings rate on the stock market is the earnings divided by the price. That's the reverse of the price-to-earnings ratio. Today, the S&P 500 is selling at about 32 times earnings. That equals an earnings yield of 3 percent. By contrast, corporate bonds yield 6 percent. That is 3 percent more than the earnings yield on stocks.

Despite the bear market, stocks still are overvalued. So Graham might be leaning toward buying bonds or bond funds today.

"My basic rule is that the investor should always have a minimum of 25 percent in bonds or bond equivalents," Graham said in the Forbes article. "Investors should also keep a minimum of 25 percent in stocks."

If Graham were alive today, he might note that there are a fistful of mutual funds that invest based on his criteria.

They include: Mutual Shares, Oak Value, Gabelli Asset, Gabelli Growth, Royce Value, Pennsylvania Mutual, Quest for Value and Windsor and Windsor II.

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Alan Lavine and Gail Liberman are husband and wife columnist and authors of The Complete Idiot's Guide To Making Money With Mutual Funds, (Alpha Books).


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