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Back to Even and Still Bullish
By: Dr. Charles Lieberman
Date: 7/26/2010
The equity market has recovered to being even for the year to date, overcoming a possible credit crisis in Greece and Europe, as well as fears of a double dip recession at home. While the economic outlook is "unusually uncertain", it is the pace of the recovery that is most subject to question, more than its sustainability. Notwithstanding these concerns, corporate profits continue to increase at a solid pace, cash is accumulating, and stocks have become cheap. This offers an excellent entry point for investors, who are able to hang in despite the market's volatility.
Consumer confidence remains depressed and far weaker than spending, which is entirely normal for this stage of a recovery. In previous recoveries, consumers increased spending long before their confidence improved. Indeed, real spending has increased at a 3.4% pace so far this year, a solid showing, although short of policymaker's needs to stoke a strong economy. But consumer finances are improving, as job growth has resumed, debt is falling, savings rates have increased, default rates are now declining, and asset values are rising again.
Prospects for the corporate sector are unambiguously bright. Earnings reports are coming in this quarter well above expectations, yet again, and companies are typically raising guidance. Cash on the balance sheets of the S&P 500 is about $1 trillion and building rapidly, but earning nothing. Companies have held on to this cash hoard as protection against another financial meltdown, yet at some point must put this cash to work. This is reflected in the persistent string of acquisition announcements, stock buybacks, dividend increases and capital reinvestment programs. Cash continues to build, nonetheless.
As usual, investors are always doing the wrong thing. Pessimism over the outlook is very high, as is evident by investment newsletters, surveys by the American Association of Individual Investors, or fund flows into bond funds and out of stock funds. It is this lack of confidence in the investment outlook that enabled stock valuations to become so cheap, as measured by the market's price earnings multiple below 12. But as suggested by the Oracle of Omaha, "Be greedy when others are fearful and fearful when others are greedy" or as suggested by Wall Street wisdom, "It's hard to get too badly hurt when you fall out of a basement window." Equity returns may be disappointing over the past 10 years, but it is this poor history and cheap valuations that create the extraordinary opportunity for the period ahead.
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