Spokane Journal of Business

Despite some pessimism, investors should be bullish on '14

Look for sectors that do well in recovering times, steer clear of gold market

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“There are only two kinds of forecasters—those who don’t know, and those who don’t know they don’t know.” - John Kenneth Galbraith, economist

Yes, it’s that time of year—when Wall Street starts putting out projections for the market year to come. Personally, I’m not going to try to place values on an index a year away. Nonetheless, I thought I’d offer my big picture thoughts with the understanding that if these don’t work out as discussed, please consider this article as having been a submission for an amateur comedy essay.

Where are we now

Nothing much has changed over the past few months. The economy is continuing to grow slowly, but it is growing and getting better. (Economic growth is an important fuel that allows equity markets to grow, but the pace of that growth has very little to do with returns in the equity market.) In contrast, getting confident about the sustainability of growth will be a meaningful contributor to the outperformance of stocks over bonds, in my opinion.

Right now, there are no signs of distress in the financial markets, here or globally, nor any emerging weakness in our economy. And yet, markets are still priced to caution and risk aversion. 

It’s my strong belief that the much-talked-about market froth isn’t real. The main reason is simply because folks are actually talking about bubbles. Typically, bubble blather tends to be self-deflating. It creates fear, which drives expectations lower, creating more of that wall of worry for stocks to climb. The real time to worry is when markets are soaring and bubble talk is AWOL, when euphoria has taken control.

I offer this as an example of that circumstance. From the archives of the New York Times, a March 24, 2000, article includes the line, “This year shall be the entrance into that new era. You would be mistaken if you presumed that the rise in technology stocks is a mere bubble.” This is definitely euphoria, for shortly after this the market began a large retrenchment.

Liz Ann Sonders, chief market strategist at Charles Schwab, said the investment community has been mostly “begrudging” in its attitude toward a market that continues on an upward trajectory. She added that, “There’s certainly no cohort that’s gone hog-wild in this market. I think we’re no worse than sort of the middle innings of this thing.” Smart lady.

Today, investors are far from euphoric. They’re perhaps a bit happier than earlier this fall, what with the government shutdown and debt ceiling debacle. But those signs of optimism are only mildly improved from the wide skepticism of the past 4 1/2 years. Forward price-to-earnings ratios remain below their long-term averages and have yet to see anything like the valuation run-up typical of late bull markets.

Sure, you can make a case that a correction is in order, given the length of the market’s advance. Some could say we’re overdue. Corrections are always possible and we haven’t seen one in a while. A correction isn’t a certainty, but investors should always be mindful of the possibility. It’s not a reason to bail, to be sure. 

In any case, I favor the opposite argument: With low inflation, high liquidity, low interest rates, and a broadly improving global economy to help earnings, we remain in an extremely good environment for stock. Plus, almost all bull market corrections are triggered by a Fed rate hike or a spike in oil prices. Neither of those seems to be in the works right now.

Looking ahead

“On what principle is it,” wondered Lord Macaulay in 1830, “that when we see nothing but improvement behind us, we are to expect nothing but deterioration before us?” 

A lot of people have held this type of perspective since 2009. Most of your favorite doomsayers have track records that you wouldn’t wish on your worst enemy. It’s one thing to be aware of the potential for terrible things to happen; it’s quite another to give up altogether. I hope someone else has been managing their money.

I look for continued overall positive results for the markets going forward. Here’s some of the reasons why I believe that.

In her confirmation testimony before the Senate, Janet Yellen offered these views. She said, “I consider it imperative that we (the Fed) do what we can to promote a strong recovery; it’s important not to remove support.” She also said that, “Stock prices have risen pretty robustly, but if you look at traditional measures such as price-earnings ratios, you would not see stock prices in territory that suggests bubble-like conditions.” 

Abby Joseph Cohen, the longtime, highly regarded investment strategist at Goldman Sachs, says, “Value remains in the U.S. stock market, pointing to price-earnings ratios that are lower now than the last time stocks were near these levels.” 

Where’s the fuel for a continued move higher coming from? From the sidelines, I believe. Check this data out from BlackRock, the world’s largest money manager. According to their studies, U.S. investors held 48 percent of investable assets in cash, with 18 percent in stocks and 7 percent in bonds. By way of comparison, the 18 percent figure we see today for stocks is actually closer to the 16.5 percent number registered at the bottom of the secular bear market in 1982. 

So, how much cash is just lying about, earning almost nothing? BlackRock says it’s $7 trillion of bank savings deposits, $0.7 trillion of retail money market funds, $0.6 trillion of small-denomination time deposits, and $1.4 trillion in checking accounts.”  And let’s not forget the $2.5 trillion parked in bank reserves. The vast majority of this is held as “excess reserves,” which the nation’s banks are apparently quite happy to hold and which pay them all of 0.25 percent. If even a small amount of these nonproductive assets move into the stock market, that’s a lot of potential energy.

As I’ve been suggesting all year, I believe that you should definitely consider positioning a chunk of your investments into those sectors which have historically benefited from improving economic conditions. These include industrials, consumer discretionary, mid-stream energy, and tech stocks. It’s best to move away from the more defensive, more interest rate sensitive areas.

Gold? Not a chance. Gold pays neither interest nor dividends. So, a rise in interest rates tends to make bonds and other investments much more attractive by comparison. Further, with inflation remaining relatively low, there’s even less incentive to own the stuff.

The folks at S&P/Dow Jones Indices say that in the S&P 500, about 40 percent of the revenue of those 500 companies now comes from outside the United States. Investors who think that they’re buying only American companies are actually getting a global portfolio. I believe the point is that, in today’s world, it’s much more important to consider companies, and the industries they’re in, than the country where their headquarters is located.

The MINT economies deserve some longer-term attention too. These include Mexico, Indonesia, Nigeria and Turkey. All have favorable demographics for at least the next 20 years, and their economic prospects are interesting.

In closing, I think it’s important that, regardless of what the markets do this coming year, long-term investors should keep their focus toward the long term and keep emotions at bay. Earnings and revenues continue to grow, although still slowly, and beat expectations. Many parts of the world economy are accelerating—all great fuel for future earnings growth. Many investors continue to overlook these positives, however, as sentiment remains firmly rooted in skepticism. However, this gap between sentiment and reality is a bullish feature as it tends to lay the groundwork for even more all-time highs ahead.



Michael Maehl is an independent financial adviser and Spokane-based senior vice president of Opus 111 Group LLC, a Seattle-based financial services company.

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