Buy Risk Assets
Before discussing the current investment setting, a quick review of the longer term picture for the markets is appropriate. We continue to believe that the U.S. stock market remains in a secular bear phase since the 2000 peak. We also believe that the past 10 years of ups and downs for the market are similar to what occurred in 1938-1955 and 1966-1982. Both of those periods marked long consolidation periods with cyclical movement up and down, but no breakout to the upside. Based upon the precedent of these two earlier periods, the U.S. stock market may take some years before it breaks out into a secular bull phase. Meanwhile, volatility will prevail from time to time and cyclical bull and bear markets will recur.
Since Spring, 2009, we have believed that a cyclical bull market was underway and we continue to believe that such a bull trend remains in place. However, over one month ago, we noted some near term concerns about the market. Some of those concerns were: investors might become worried about growth in the U.S. as a result of the fiscal issues in southern Europe, divergent price behavior between quality and speculative stocks in the U.S. market was not likely to continue, and significant rebounds in the stock market from very depressed levels, such as March, 2009 – April, 2010 usually encountered correction of 10 – 30% before the market sustained a further advance.
Over the past month, investors have become more concerned about growth in the U.S. and Europe and to some degree China as well. The divergent stock price setting has been corrected. And the market corrected 15% from its April peak to its intra-day low in May. Moreover, other changes have occurred as well. Investor sentiment moved from very bullish to very bearish. Insider selling shifted to insider buying. The put-call ratio changed from bearish to bullish. Meanwhile the price-earnings ratio of the S&P 500 has fallen to 12 – 13x expected 2010 earnings and 11 – 12x estimated 2011 profits. Consequently, valuations are reasonable relative to their long term average price-earnings ratio of 15x. The glass appears half full, not half empty as many seem to think.
The fundamental trends of the U.S. economy remain favorable despite renewed speculation about a potential double dip. Employment and incomes are rising. Consumption is recovering. The underlying trend of the housing market is up. U.S. exports are positive. Investment spending is picking up, especially for technology. Non-financial corporations are very liquid and are spending again. Banks are lending a bit more aggressively than they had been doing. Overall, the U.S. economy should grow 3%+ in 2010. True not all segments are expanding at the same rate, but such behavior is normal at this stage of an economic recovery.
Europe will be slow to recover, but this is not a new revelation. Certainly a more constrained rebound by Europe will have some influence upon the growth of the U.S. economy. Nonetheless we believe that influence is already reflected in investor sentiment and stock prices. It is encouraging to note that today’s Wall Street Journal states that Germany’s economy is showing increasing signs of strength. The weaker euro will help Germany and other European countries realize increased exports.
Meanwhile, inflation and interest rates in the U.S. are not a current problem and may not be an issue until sometime in 2011.
Tuesday’s USA Today carried a headline reading “World of Troubles for U.S.” citing the oil spill and tensions in Korea and the Mideast. While all is not well (it never is), fundamental economic trends are not as bad as markets have been suggesting. The problem is in our heads. We need to spend more time looking at the facts and less time reacting to media and short term trades. A balanced assessment of the factors influencing the markets suggests that they are not as bad as the pundits would suggest. Consequently, we recommend putting some cash to work in risk assets.
A. Marshall Acuff, Jr., CFA
Chair, Cary Street Partners Investment Committee
Cary Street Partners Investment Advisory, LLC