One of my favorite quarterly commentaries to read. Here is the current market view from Trapeze:
After a significant recovery from the March '09 bottom during which our equity composites outperformed, the markets suffered a setback in the last quarter, during which our portfolios underperformed from the unusual decline in Canadian small caps—the TSX Venture Exchange down 17% in the quarter and down 22% from its early March high. Investor psychology in the quarter became excessively negative even though stocks generally, and the companies in our portfolios, became even more compelling with discernible progress ahead. In our view the current investor mindset does not correspond with what should really matter to an investor.
Mind Games
As the markets declined in the quarter, stocks became significantly oversold from the negative psychology resulting from the negative headlines. And there were and are many of them: the financial rescue of Greece, and the implications for Europe and its other precarious economies such as Ireland and Portugal and, now, Spain and Italy too; the potential slowing of the Chinese economy; supply chain disruptions from Japan’s earthquake; poor U.S. jobless numbers; a higher than expected U.S. trade deficit; continued falling U.S. house prices; a potential deadlock in the U.S. budget talks and the debt ceiling debate; the Fed cutting its forecasts for economic growth; potential headwinds from government austerity programs; fear of a slowing economy; fear of deflation; fear of inflation; rising commodity prices and declining stock prices. A mindset of fear and fear. CNBC recently reported that investors were more concerned about the economy than at any other time during the past five years; a CBS poll found that 39% of Americans believe the economy is in a state of permanent decline. We all know the mind can play tricks. Risk aversion. That wall of worry. But when perceived risk is so great it is typically reflected more than warranted in depressed share prices. It’s in the market. The news doesn’t have to be good, just not as bad as everyone believes.
What Matters
What matters is that, while global growth has slowed somewhat, all of the global liquidity should induce increased growth later this year, particularly as China’s tightening ends and Japan resumes its production and growth, as will U.S. factories. China’s economy still managed to grow 9.5% in Q2 from a year earlier and India continues strong too. U.S. manufacturing activity picked up in May. U.S. purchasing manufacturer’s index improved in June. Industrial commodity prices remain strong. The Dow Jones Transports recently hit an all-time high. U.S. housing sales will improve from prices stopping their decline, from shrinking loan delinquencies, from low new housing starts, from diminished inventories, from inflationary pressures, from easier credit and, best of all, from affordability. Canadian housing starts strengthened in June. A record high level of Canadian firms expect to increase employment over the next year as sales and investment in machinery continue to rise.
U.S. interest rates are at historical lows and the yield curve remains steep—incentives for new lending. Fed stimulus remains in the system even if the Fed were to stop its asset purchases. And if more monetary stimulus is needed the Fed will supply it, no matter how it equivocates. Meanwhile, personal incomes are rising and U.S. consumers are getting stronger—a savings rate of 5% in May, and the May PCE price index up 0.3%—an inducement not to defer spending. The ratio of consumer debt payments to incomes is the lowest since '94. The S&P 500 Retailing Index just hit a record high. U.S. exports should strengthen from the weak dollar and stronger overseas growth. While U.S. unemployment remains high as state and local governments shed jobs, private sector job growth is slowly improving—all as it should be. Employment will improve as manufacturing and housing pick up. State finances are improving—California, New York and Texas, for example. The U.S. debt ceiling will be raised and a favourable deficit-cutting bipartisan deal reached. Natural tsunamis can’t be avoided—man-made ones can. Global growth should accelerate. Left-wing governments everywhere are moving to the centre right and compelled to get their fiscal houses in order, ultimately good for growth and good for business. Short-term austerity for long-term prosperity. Or, as value investors prefer, “short-term pain for long-term gain.”
What Really Matters
But, for we narrow-minded stock investors, what really matters is that valuations are unusually compelling, that monetary conditions are very favourable, and, finally, that the psychology has become sufficiently negative to induce the recent rally. To continue climbing the wall of worry. The big caps first, with the smaller, in typical fashion, immediately following.
What really matters to us, as stock investors, are corporate earnings and their future growth, and what we have to pay currently for those businesses. Oh, and what we think others are likely to pay in the future for the then earnings, in order for us to realize our estimated potential gain.
What really matters to us is that currently our stocks are unusual bargains, many trading at the same depressed valuations as their March '09 lows. What really matters is that S&P 500 forward earnings have risen to a new record high and that the forward multiple dipped below 12x in mid-June before the recent rally, when fair value is over 15x. What really matters is that healthy profits will encourage businesses to invest, hire and grow. And rebuild inventories, currently low relative to sales. And that earnings this year are expected to be up 18% and revenues 8.5%, year over year.
Hays Advisory notes that whenever its dependable Monetary Composite is as bullish as it is now, over the next 18 months the stock market could be up by over 30%. And its Valuation Composite suggests the odds are high that the stock market will be much higher over the next 4-5 years. It believes that bad news is good since it causes stocks to be cheap and monetary liquidity to be plentiful.
What really matters is that corporations are flush with cash which should allow more capital spending and employment. And increased share buy-backs, dividends and merger and acquisition activity. And what really matters is that, in terms of protecting purchasing power, stocks are safer than bonds.
With earnings right back to their long-term trend line and at all-time highs, the S&P 500 is selling at a 15% discount to our Fair Market Value. Yet, bonds, with paltry yields, remain favoured by U.S. households and pension funds over equities, so equity allocations are at multi-year lows. The stock market will be propelled higher by the mountain of cash on the sidelines as the overwhelming fear ultimately abates.
We think now is an extraordinarily good time to invest. The large-cap indexes are undervalued. Stocks today are, by far, the preferred asset class compared to bonds and cash. Our TRAC™ and TRIM™ work are positive—a number of markets and sectors appear to have inflected up from key support levels. And, most important, risk-reward parameters for our individual holdings are so highly favourable.
After a significant recovery from the March '09 bottom during which our equity composites outperformed, the markets suffered a setback in the last quarter, during which our portfolios underperformed from the unusual decline in Canadian small caps—the TSX Venture Exchange down 17% in the quarter and down 22% from its early March high. Investor psychology in the quarter became excessively negative even though stocks generally, and the companies in our portfolios, became even more compelling with discernible progress ahead. In our view the current investor mindset does not correspond with what should really matter to an investor.
Mind Games
As the markets declined in the quarter, stocks became significantly oversold from the negative psychology resulting from the negative headlines. And there were and are many of them: the financial rescue of Greece, and the implications for Europe and its other precarious economies such as Ireland and Portugal and, now, Spain and Italy too; the potential slowing of the Chinese economy; supply chain disruptions from Japan’s earthquake; poor U.S. jobless numbers; a higher than expected U.S. trade deficit; continued falling U.S. house prices; a potential deadlock in the U.S. budget talks and the debt ceiling debate; the Fed cutting its forecasts for economic growth; potential headwinds from government austerity programs; fear of a slowing economy; fear of deflation; fear of inflation; rising commodity prices and declining stock prices. A mindset of fear and fear. CNBC recently reported that investors were more concerned about the economy than at any other time during the past five years; a CBS poll found that 39% of Americans believe the economy is in a state of permanent decline. We all know the mind can play tricks. Risk aversion. That wall of worry. But when perceived risk is so great it is typically reflected more than warranted in depressed share prices. It’s in the market. The news doesn’t have to be good, just not as bad as everyone believes.
What Matters
What matters is that, while global growth has slowed somewhat, all of the global liquidity should induce increased growth later this year, particularly as China’s tightening ends and Japan resumes its production and growth, as will U.S. factories. China’s economy still managed to grow 9.5% in Q2 from a year earlier and India continues strong too. U.S. manufacturing activity picked up in May. U.S. purchasing manufacturer’s index improved in June. Industrial commodity prices remain strong. The Dow Jones Transports recently hit an all-time high. U.S. housing sales will improve from prices stopping their decline, from shrinking loan delinquencies, from low new housing starts, from diminished inventories, from inflationary pressures, from easier credit and, best of all, from affordability. Canadian housing starts strengthened in June. A record high level of Canadian firms expect to increase employment over the next year as sales and investment in machinery continue to rise.
U.S. interest rates are at historical lows and the yield curve remains steep—incentives for new lending. Fed stimulus remains in the system even if the Fed were to stop its asset purchases. And if more monetary stimulus is needed the Fed will supply it, no matter how it equivocates. Meanwhile, personal incomes are rising and U.S. consumers are getting stronger—a savings rate of 5% in May, and the May PCE price index up 0.3%—an inducement not to defer spending. The ratio of consumer debt payments to incomes is the lowest since '94. The S&P 500 Retailing Index just hit a record high. U.S. exports should strengthen from the weak dollar and stronger overseas growth. While U.S. unemployment remains high as state and local governments shed jobs, private sector job growth is slowly improving—all as it should be. Employment will improve as manufacturing and housing pick up. State finances are improving—California, New York and Texas, for example. The U.S. debt ceiling will be raised and a favourable deficit-cutting bipartisan deal reached. Natural tsunamis can’t be avoided—man-made ones can. Global growth should accelerate. Left-wing governments everywhere are moving to the centre right and compelled to get their fiscal houses in order, ultimately good for growth and good for business. Short-term austerity for long-term prosperity. Or, as value investors prefer, “short-term pain for long-term gain.”
What Really Matters
But, for we narrow-minded stock investors, what really matters is that valuations are unusually compelling, that monetary conditions are very favourable, and, finally, that the psychology has become sufficiently negative to induce the recent rally. To continue climbing the wall of worry. The big caps first, with the smaller, in typical fashion, immediately following.
What really matters to us, as stock investors, are corporate earnings and their future growth, and what we have to pay currently for those businesses. Oh, and what we think others are likely to pay in the future for the then earnings, in order for us to realize our estimated potential gain.
What really matters to us is that currently our stocks are unusual bargains, many trading at the same depressed valuations as their March '09 lows. What really matters is that S&P 500 forward earnings have risen to a new record high and that the forward multiple dipped below 12x in mid-June before the recent rally, when fair value is over 15x. What really matters is that healthy profits will encourage businesses to invest, hire and grow. And rebuild inventories, currently low relative to sales. And that earnings this year are expected to be up 18% and revenues 8.5%, year over year.
Hays Advisory notes that whenever its dependable Monetary Composite is as bullish as it is now, over the next 18 months the stock market could be up by over 30%. And its Valuation Composite suggests the odds are high that the stock market will be much higher over the next 4-5 years. It believes that bad news is good since it causes stocks to be cheap and monetary liquidity to be plentiful.
What really matters is that corporations are flush with cash which should allow more capital spending and employment. And increased share buy-backs, dividends and merger and acquisition activity. And what really matters is that, in terms of protecting purchasing power, stocks are safer than bonds.
With earnings right back to their long-term trend line and at all-time highs, the S&P 500 is selling at a 15% discount to our Fair Market Value. Yet, bonds, with paltry yields, remain favoured by U.S. households and pension funds over equities, so equity allocations are at multi-year lows. The stock market will be propelled higher by the mountain of cash on the sidelines as the overwhelming fear ultimately abates.
We think now is an extraordinarily good time to invest. The large-cap indexes are undervalued. Stocks today are, by far, the preferred asset class compared to bonds and cash. Our TRAC™ and TRIM™ work are positive—a number of markets and sectors appear to have inflected up from key support levels. And, most important, risk-reward parameters for our individual holdings are so highly favourable.
