US stocks approached the March 16th levels that marked the YTD low, and also the start of year values. Given that stocks peaked 6 weeks earlier with a YTD rise of 9.0%, our clients have called wondering if this slide marked the start of another financial meltdown. Thankfully, no! As we have remarked several times already this year. US stocks are fairly to slightly overvalued during a slowdown in world economic growth due to supply chain problem following the Japanese earthquake and tsunami, poor job numbers in the US, elevated oil prices following unrest in the Middle East, particularly Libya, rising interest rates and inflation fears in emerging markets such as China, and last and of least concern to us, the effective bankruptcy of Greece.
We remain sanguine because interest are low and will remain low for the short and medium term; there is much labor and capacity slack in developed economies, so inflation is not a threat; last and most important to us, the world's banks have deleveraged substantially in the last two years. Why does that matter? Less leverage means more capital means more resilience to absorb probable losses in Greek debt, and possibly also, Spanish, Irish and Portuguese debt. Sovereign debt crisis seem to occur every fifteen years (Latin America in the early 1980's, Asia in the late 1990's, Europe now) as bankers, credit agencies and investors apparently have short memories. If Greece in fact defaults, some European banks will lose some money but will not lose all their capital as we saw in 2008 among Bear Stearns, Lehman Brothers, AIG and certain European banks.!
High net worth families still "scared to death" of stocks
Our general philosophy is that funds needed within 12 months (down-payment on a house, a college tuition payment) should be kept in money markets, even at today's negligible rates. Funds needed in the next 1-5 years (for example, to fund a retired client's monthly "allowance" should be in bonds or bond funds. Funds not needed for at least 5 years (for example, to fund a retirement) should be in stocks. However, we have a number of clients with large cash positions unwilling to invest in anything except money market accounts, in some cases spread across multiple banks and brokers to maximize FDIC and SIPC insurance coverage. That's an extremely safe position for now, but at the same time prevents that capital from growing to support future needs!
Fidelity Investments in Boston surveys over a 1000 families with at least $1 million in investable assets every October for the "Fidelity Millionaire Outlook." As of 2010, US High Net Worth families were barely more confident than in 2009 when memories of the financial meltdown were fresh. The survey asked millionaires to rate their outlook on a scale of 100 (Very Bullish) to -100 (Very Bearish) on five areas:
Though off the lows, millionaires remain deeply bearish about the economic outlook, and are at best neutral about the outlook for stocks.
In the annual survey of "The State of the American Dream" provided by Xavier University:
83% say of American adults say they have less trust in "politics in general" than they did 10 or 15 years ago
- 79% say they have less trust in big business and major corporations
- 78% say they have less trust in government
- 72% report declining trust in the media
- 65% believe America in in decline
- 54% believe "that my freedoms are being taken away."
In the context of these surveys, no wonder getting clients to invest in their future has never been tougher. Often we hear, "I understand that I need to invest in stocks, but I want to wait until the situation is much improved." To which we reply, "By the time clarity is achieved, stock prices will be much higher!"
How clients see investment trends
In the Paleolithic times, 200,000-10,000 years ago, humans obtained food primarily by hunting. If you wanted to find the caribou, follow the caribou tracks! We theorize that modern humans are still relying on this instinctual skill when evaluating investments. Investors project an up-trend (internet stocks, housing, gold) to infinity and project a down-trend (stocks in 2008-9) to zero. In fact, investment trends zig-zag constantly. A more sophisticated investor uses, for example a valuation model. When stock prices are trending higher, a valuation model such as the Fed Model might suggest reducing stock exposure. Similarly, when the trend looks singularly bleak, the valuation model might suggest going fully invested!
Time spans matter also. We live in an age of instant gratification, so stock reporters tend to focus on what happened today, this week, or this month. We recognize that companies take between 1-5 years to design, implement and roll out a new product or service, and make our investments accordingly. We believe that what happens on a day by day basis is random.
Here are a series of charts (all US S&P 500) of gradually increasing times span:
For In the last six weeks, stocks are clearly in a downtrend, though we've had a nice rally the last 4 days.
Over the last 6 months, we see that a long term up-trend is just a 10% trading range. At the top of the range, stocks are slightly overvalued, while at the bottom, undervalued. In the absence of substantial news, prices drift up and down through the range.
From the market low of March 9th, 2009, stocks look benevolent, doubling in under 24 months. The downturn of the last 6 weeks is less substantial than the 2010 summer slow-down.
Over the last 13 years, the stock market doubled and halved twice. A lot of people, we think, fear another 50% cut rather than a break out past 1560 to the upside
Finally, a chart of the S&P 500 (log scale) running back to 1927. We see a couple of long periods during which stock prices barely budged (1929-1949, 1970-1980, 1998-2011) though dividend yields generated a positive total return. After each period of consolidation, stocks moved higher.
We can imagine scenarios where stocks became valueless. For example, after the Russian revolution, Russian stocks became worthless. German stocks did not become valueless following the collapse of the Nazi regime in 1945 and indeed grew 900% by 1960. US stocks did not become worthless during the Great Depression, the outbreak of World War II, the Cuban missile crisis, the assassination of Kennedy, the 9/11 attacks or any other horror of the 20th and 21st centuries. If the Earth was struck by a meteor, we imagine stocks would be worthless, but none of us would be around to care.
In this context, not investing in stocks is like saying that you won't leave your house because you might be hit by a bus, struck by lightning or eaten by a shark. All of those events are possible, but you need to get on with your life. Yes stocks can fall, but beyond every decline is another rally. Meanwhile if you don't invest in stocks, you won't be able to retire - ever!
US earnings reports start the second week of July. Research in Motion's negative pre-announcement this week is the only earnings miss worth mentioning. Earnings among financial service stocks are under pressure. Without junky mortgage backed securities to sell, not much profit on Wall Street these days (and we are totally cool with that!) Excluding financials, earnings are expected to grow 11% in Q2, though year over year revenues are expected to be flat.
Most economists expect GDP growth to accelerate in the second half of the year as the Japanese supply chain issues are sorted out and commodity prices moderate (oil peaked at $114 in April, last $93.4/barrel.) The jobs situation, with negligible jobs added and the unemployment rate over 9.1%, remains our biggest worry. From Morningstar's calculations, stocks are undervalued by 4%. By the Fed model, stocks are at present undervalued by 23%. Let's be conservative and project that stocks are undervalued by 10%. Even so, we regard now as a low-risk entry point. If you are sitting on the sidelines with cash, talk to us now!