The stock market has sold off approximately seven percent over the past eight weeks as investors have recently chosen to view the economic glass as half empty rather than half full. With this in mind, as part of a two part series, last week we addressed five negatives that were weighing on the stock market, including the weak housing market, high unemployment rate, austerity measures proposed at all levels of the public sector, the paradox of thrift and a heating up of the political rhetoric. This week, we’ll address some of the positives that should ultimately take hold and send stocks higher or at least provide a floor within a few percentage points of current levels.
The first positive is that given current valuations stocks have most likely already factored in the weak housing and labor markets and that only a further, marked weakening, will send stocks lower. If history is any guide, the housing bubble which was pricked during the latter part of 2007 and into 2008 will at some point recover a small portion of their losses and then flat-line for awhile. In other words, the bloom is off the housing market rose. However, absent a further decline, most homeowners are not assuming any appreciation in the value and most investors are not assuming that the housing market will participate in an economic recovery. Any upside in the housing market will be welcomed by homeowners and investors alike.
The second positive is that interest rates on deposits remain at or near zero percent. Individuals either saving for the education of their children, their retirement or receiving retirement income are not able to achieve their objectives with money earning zero. They will look for alternatives which will include stocks as well as bonds. And why not, many individual stocks pay dividends far in excess of three percent as do mutual funds. Many individuals will shoulder some risk to principal for an opportunity to pick up a return better than nothing, which is what money in the bank is paying.
The economy continues to move forward, albeit at a sluggish pace. Given all of our economic woes noted above as well as others, it is no surprise that many believe our country remains in a recession. The fact of the matter is that we are moving forward, it is just not at a blistering pace. And for every month that passes, our economy continues to heal – individuals repair their balance sheets, corporations earn money and the public sector right-sizes. Ultimately, this will lead to a more robust recovery assuming that there are no external shocks to the economy. (We realize this is a big assumption.)
The United States is a smaller contributor to global economic growth. This may sound like a negative, but it is not. The global economic pie is getting bigger and despite the fact that our percentage of this pie is shrinking, the absolute value of that pie continues to rise. The vast majority of S&P 500 companies derive more than half of their revenue and net income from outside the United States. This bodes well for corporate earnings which should eventually help lower our unemployment rate.
The final potential positive influence on stock prices is the high degree of skepticism and cynicism on both Main Street and Wall Street. The stock market has gone nowhere for the past twelve years and investors are beginning to wonder if it will ever rise again. What they don’t know is that this market action is very similar to past cycles where stocks appreciate over a longer period of time which is then followed by a digestion of those gains over a similar period of time only to then be followed by another long period of appreciation. We believe at some point in time increasing corporate profits and improving fundamentals will ultimately push stocks higher. When this occurs is anybody’s guess. However, we do know that the time will come when stocks have their day.
THE BOTTOM LINE – Remain patient. Invest according to your objectives and recognize that despite all of the negativity in the media surrounding the stock market, there is a lot of value out there, value which we believe will be unlocked over the next two to five years. We conclude that stocks remain the nicest house in a bad neighborhood and at this time the most efficient choice in helping you reach your financial objectives, when compared to bonds, cash and real estate.