Hang Ten on This Market’s Next Wave

Anyone from Hawaii will tell you that tourists make the same mistake. They think they can predict the size of the next wave by watching a few sets. A minute later, they’re floating to Alaska.

We don’t know what’s coming next--not on the beach, not on the highway and not in the markets. We didn’t expect the pounding the market delivered these last few weeks, or months, and we don’t know when it will end. The good news--and the reason we’re waxing our surfboards--is that we don’t believe that long-term investors have to know.

Is it Alan Greenspan’s fault? One argument runs like this: Higher interest rates hurt capital spending, and that lowers profits, spreading ripples deeply through our economy. Think of how technology spending has affected the computer industry. American companies, after years of letting out slack, investing heavily in computers and new technology, must now tow in some line.

Was it inevitable? Was it Greenspan raising interest rates six consecutive times in the year 2000? Maybe both. But the more important truth is that capital spending trends up over the long term, even though it’s always lumpy from year to year and cycle to cycle.

Sure, it hurts to watch stocks slipping over the edge. Many stocks, especially in the telecommunications sector, turn out to have been far overvalued given the uncertainty of the return on the billions of dollars invested in technology and acquisitions over the last five years.

The Internet threw us all off course. As a society, we plunged in and snapped up shares of unknown companies when we often should have stood back and watched from the shore. Many of us are now paying the price for paying too much for too many companies for too long. But you know what? So did venture capitalists, foreigners, money managers and your next-door neighbor. Remember, as bad as the present day might make them appear, some of these investments will actually work out in time.

Anyway, it’s the Federal Reserve’s job to oversee prices with monetary policy, not to cure the stock market’s maladies. Indeed, as Greenspan hiked interest rates, there were signs of inflation--demand outpacing supply and higher fuel prices, for example. Blaming Greenspan for current market conditions is like blaming your psychiatrist for an unhappy childhood. Well, your hour’s up. It’s time to move on. And, anyway, kicking sand might mean you miss the next good set of waves rolling up the shelf.

Our job as investors, regardless of conditions in the market, is to look to buy shares of great companies at reasonable prices. That’s a simple recipe for success in the long term, no matter what happens Monday on the Nasdaq.

Now, just because the indices are dropping, we investors shouldn’t assume the world is full of bargains. Many bears today point to a still-high average price-to-earnings ratio for the S&P; 500. Still, price-to-earnings ratios don’t tell you everything you need to know about stock prices, and it makes sense that PEs are somewhat higher given that technology and smarter business practices have boosted returns. But consider that the S&P; 500’s current PE of 23 is much higher than it was in 1991, when it stood at 15, or 1981 when it stood at just nine, according to S&P;/Barra Indexes.

What gets lost in the useless hours of debate about whether the market has hit bottom is that good companies--even world-beating companies--are approaching reasonable prices. American Express, which we hold in one of our portfolios at the Motley Fool, is near a two-year low at about 16 times earnings, all because of short-term worries about the economy. We hope it keeps slipping so we can buy more shares.

AmEx’s price isn’t dirt cheap, but it’s in the right neighborhood for a very profitable, 151-year old company with one of the most recognized names in the world. About 52 million people carry cards bearing the American Express logo in their wallets, and the proliferation of its name worldwide won’t change because the markets are in a tizzy.

So, yes, it hurts to see prices melting. It’s painful to see hard-earned money evaporating. But don’t wince so hard that you miss the deadly serious lesson in all of this white-water. There is great risk investing in untested, unprofitable companies, and a great risk investing in any company if you pay too high a price.

And remember: The sun will rise again, the market will rise over the long term, and there’s always another wave behind the one that broke this market.