A 'Justifiable' Time to Be More Exposed Than Normal to Equities

We would like to extend a Happy New Year to our newsletter readers and apologize for the two-week layoff around the holidays. While it is often useful to take a look back at the past year, that has already been done thousands of times, and really what more needs to be said about the worst year for equities since 1931. It was certainly a year that many investors would love to leave behind, but while the markets were definitely hugely disappointing in 2008–the S&P 500 dropping 38.5%– it is vital to remember that this has improved the risk/return profile substantially for long-term equity investment.

The price-to-peak earnings multiple has improved to 10.4x as the year finished with a rally. The S&P 500 reversed a four week losing trend and gained nearly seven percent, albeit with light trading volume commonly seen around the holidays. What is predicted to be a fairly ugly first quarter earnings season will not get into full swing for a few weeks, which will hopefully give the market an opportunity to continue its nascent upward momentum.

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The percentage of NYSE stocks selling above their 30-week moving average has improved to 9.8% as of Friday the 2nd. Our sentiment indicator has gained fairly consistently over the last 6 weeks and could be poised to come back to more normal values. As we have continued to note, investor sentiment overall has been at exceptionally low levels for the last three months. In addition, consumer confidence has plummeted to new lows. The pessimistic view of the economy in general has lead to a flight to the safety of Treasuries, which actually increased in price by nearly 15% in 2008.

A consensus view of the economy has clearly been formed and investors would be wise not to fall victim to the prevailing herd mentality. After all, conventional wisdom is an oxymoron. For long-term investors, this is a justifiable time to be more exposed than normal to equities, not less.

Our equity allocation model for long-term, value-focused investors continues to point to a bullish outlook for stocks. The market appears undervalued by our valuation methodology, although we are not predicting a rapid rebound to DJIA 13,000! We are simply stating that while there is plenty of macroeconomic risk in this environment, certain stocks are trading at very compelling valuations. With price-to-peak valuations around 10x and sentiment extremely depressed for some time now, we believe that investors should be looking to increase their equity exposure selectively. The stock market, statistically speaking, will tend to revert to its norms, and we have been outside of the norms (undervalued) for quite some time now.

Comments

[erniem:]

Just don't allocate money you can't afford to lose. The turbulence in the market is FAR from over.

Jan 07 10:27 AM

[patio:]

You really can't be serious.

Jan 07 11:28 AM

[E Thomas St.:]

This applies every single day of the year.


On Jan 07 10:27 AM Ernie Montague wrote:

> Just don't allocate money you can't afford to lose. The turbulence
> in the market is FAR from over.

Jan 07 01:36 PM

[prudentinve...:]

You state that "..A consensus view of the economy has clearly been formed and investors would be wise not to fall victim to the prevailing herd mentality..".

But you don't tell us what is the prevailing herd mentality. My readings since the Santa Obama rally are that the herd is saying this is just another mild recession, the lows are behind us, and the market will soon skyrocket.

I agree that wise investors need not fall victim to the herd.

Jan 07 02:59 PM

[investor88:]

May not be wise to assume business as usual, turbulence in the market far from over.

Jan 08 09:13 AM

[basehitz:]

You cite price/peak earnings. Assuming that was the last peak, my comments are as follows:

1) we just came off a period where profit margins were at historic highs. From 1955 until recently, 5.5-7.5% was the approximate range. The last peak was 8.5%, an outlier and hence not reasonable for estimating future valuations. So knock 1/3 past earnings just to get back in the range and redraw that graph and you see it is not especially attractive now.

2) besides margins, much of that profit came from an oversized financial sector, and we know now how they put up those numbers. . . huge leverage on top of risky investments. Not gonna happen again.

3) we are now at historically high debt levels measured both as ratio of debt to national income and total debt to GDP. Using the latter ratio, we are > 300% of GDP. The ONLY time in history we were even close to this level of indebtedness was. . . ready for this? . . . 1929. The research was published by Marc Faber in 2005. He is not Dr Doom cause he's a grouch. Our national balance sheet sucks

You analyst guys need to stop looking at the last 10 years or 30 years of data and drawing conclusions. By many measurements, we are in unchartered territory. And Mr. Obama can try all the programs he wants, if the Chinese and others don't buy our debt in increasingly outrageous proportions, we are really screwed.

Now for the good news. All this money printing is gonna cause something to happen. Assuming we don't get financial Armageddon and demand at least stabilizes, commodities especially energy seems like a safe place to hide, and probably fairly soon. Today I bought some UNG. If oil continues to get hammered and I'll add USO.

But US stocks, be careful.

Jan 08 02:43 PM