The 11% drop in the stock market in May has a lot of investors worried. Everyone remembers 2008, and nobody wants to relive it. Throw in the high unemployment rate, the breathtaking speed of the growth of our national debt, and the possibility of default in the government bonds of Greece, Portugal and Spain, and many investors wonder why they should ever invest in the market. Even though 2009 turned out to be a good year, people are still skittish. But is the outlook for stocks really that bleak?
While the risks are real, I believe there are six reasons to be positive about the outlook for stocks over the next 6 – 12 months, even if the market decides to go somewhat lower first:
1. Valuations are low. Based on the consensus earnings estimate for the S&P 500 for 20101, the PE (price to earnings) ratio of the index is about 13, well below the average over the last 20 years. And prices are still 10% lower than just one month ago.
2. Corporate profits are continuing to grow. Earnings for the S&P 500 companies were up substantially in the last two quarters. Consensus estimates are that they will continue to increase at a good clip at least through the end of 2011.
3. Although still weak, hiring has resumed. The monthly trend in non-farm payroll employment stopped getting worse a year ago. Monthly job losses started to diminish in the fall. Since the beginning of 2010 the economy has actually been adding jobs, with an increasing amount each month. It’s not enough yet to start to absorb the millions of jobs that have been lost, but it’s a beginning. If the positive trend continues, as I believe it will, it will help discretionary spending as well as the housing market.
4. The Fed (Federal Reserve Board) will, in my opinion, keep targeted interest rates low for an extended time. The problems in Greece, along with high unemployment in the U.S., low inflation, and the strengthening dollar should keep the Fed from raising interest rates until at least late this year, if not longer.
5. Investor psychology has turned pessimistic since the end of April—which is actually good. There are many ways to take a reading of this—statistics about market trading behavior (put-call ratios, Arms index, etc.), surveys, listening to guests on the business programs, and so on. Put it all together (or just ask your friends), and we find that pessimism is close to an extreme—which has been a very good contrary indicator for the stock market in the past. (Investors tend to feel the most negative near market lows, and the happiest near peaks.)
6. Political changes are in the wind. Many people are very concerned about the expansion of government power, entitlement programs, and spending over the last 15 months, and feel that Congress is out of control. The $13 trillion debt and the annual $1 trillion+ deficit are scaring people. If the trend in recent elections and primaries continues, many incumbents are likely to be voted out of office in November, and the next Congress will be decidedly more conservative. If so, the ability of the current majority party to pass new spending programs will be reigned in somewhat, which could be the start (but no more than a start) of returning to fiscal prudence. If it happens, I believe it will be beneficial for the stock market.
Of course, no matter what the outlook, you should never have more invested in stocks, or take more risk, than what is appropriate for your needs, as spelled out in your investment plan. Your investments in stocks should be widely diversified to avoid taking unexpected big losses in individual stocks. Buying and holding forever, as is often promoted by the big brokerages and mutual funds, is not the right approach—but neither is active short term trading that plays into your emotions (also often promoted by stockbrokers who need commissions). You should have a good plan, based on your future needs for a secure retirement, and you should be able to go to sleep at night.
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1 Garzarelli Capital, Inc., Sector Analysis Monthly Monitor, 5-14-2010
While the risks are real, I believe there are six reasons to be positive about the outlook for stocks over the next 6 – 12 months, even if the market decides to go somewhat lower first:
1. Valuations are low. Based on the consensus earnings estimate for the S&P 500 for 20101, the PE (price to earnings) ratio of the index is about 13, well below the average over the last 20 years. And prices are still 10% lower than just one month ago.
2. Corporate profits are continuing to grow. Earnings for the S&P 500 companies were up substantially in the last two quarters. Consensus estimates are that they will continue to increase at a good clip at least through the end of 2011.
3. Although still weak, hiring has resumed. The monthly trend in non-farm payroll employment stopped getting worse a year ago. Monthly job losses started to diminish in the fall. Since the beginning of 2010 the economy has actually been adding jobs, with an increasing amount each month. It’s not enough yet to start to absorb the millions of jobs that have been lost, but it’s a beginning. If the positive trend continues, as I believe it will, it will help discretionary spending as well as the housing market.
4. The Fed (Federal Reserve Board) will, in my opinion, keep targeted interest rates low for an extended time. The problems in Greece, along with high unemployment in the U.S., low inflation, and the strengthening dollar should keep the Fed from raising interest rates until at least late this year, if not longer.
5. Investor psychology has turned pessimistic since the end of April—which is actually good. There are many ways to take a reading of this—statistics about market trading behavior (put-call ratios, Arms index, etc.), surveys, listening to guests on the business programs, and so on. Put it all together (or just ask your friends), and we find that pessimism is close to an extreme—which has been a very good contrary indicator for the stock market in the past. (Investors tend to feel the most negative near market lows, and the happiest near peaks.)
6. Political changes are in the wind. Many people are very concerned about the expansion of government power, entitlement programs, and spending over the last 15 months, and feel that Congress is out of control. The $13 trillion debt and the annual $1 trillion+ deficit are scaring people. If the trend in recent elections and primaries continues, many incumbents are likely to be voted out of office in November, and the next Congress will be decidedly more conservative. If so, the ability of the current majority party to pass new spending programs will be reigned in somewhat, which could be the start (but no more than a start) of returning to fiscal prudence. If it happens, I believe it will be beneficial for the stock market.
Of course, no matter what the outlook, you should never have more invested in stocks, or take more risk, than what is appropriate for your needs, as spelled out in your investment plan. Your investments in stocks should be widely diversified to avoid taking unexpected big losses in individual stocks. Buying and holding forever, as is often promoted by the big brokerages and mutual funds, is not the right approach—but neither is active short term trading that plays into your emotions (also often promoted by stockbrokers who need commissions). You should have a good plan, based on your future needs for a secure retirement, and you should be able to go to sleep at night.
____________________________________
1 Garzarelli Capital, Inc., Sector Analysis Monthly Monitor, 5-14-2010
