By Tom Bradley
We continue to be barraged with negative news. Even the most positive economists are projecting slow growth for the next few years, and the bearish ones, whose names all seem to start with ‘R’, send chills down my spine. One sentence in Connor, Clark & Lunn’s September Outlook pretty much captures the concerns.
“Consumer, business and investor confidence are poor, retail sales are sluggish, credit formation is weak, unemployment rates continue to rise, house sales and prices are falling again, the system is choking on debt and the majority of leading indicators have rolled over and are heading down at an alarming rate.”
In this context, we continue to counsel caution, but we’re not recommending our clients stray too far from their long-term asset mix. I say that because there are some offsetting positive factors that don’t get much press. Rather than wallow in the gloom, we need to keep some perspective. Consider the following:
- Price/Earnings multiples are low. There are plenty of high-quality, well-financed companies trading at 12 times earnings, or less. This compares to U.S. treasuries that carry a multiple of 40 times. As CCL calculates it, the Equity Risk Premium, which factors in interest rates, credit spreads and economic growth, is at its highest reading ever (i.e. good for making money).
- Corporate balance sheets are strong. Indeed, they’re stronger than all but a few countries. This means corporations have money to spend on capital assets and acquisitions. If we do get a pickup in mergers and acquisitions activity, the stock market will love it.
- Negative sentiment usually presages a major investment opportunity. Today equity mutual funds are in redemption and investors are asking why they own stocks at all. Indeed, in recent weeks, there have been a number of articles on “The End of the Equity Cult”. In his July 19th letter, Howard Mark of Oaktree Capital Management phrased it well. He said, “Markets are safer when fear balances greed, and when worry about losing money balances worry about missing opportunity.” We needn’t worry about greed right now and all the worry is focused on losing money.
In my meetings with industry veterans over the last month, the themes have been consistent. Why would I buy bonds yielding less than 3%? Equity returns are going to be modest over the next 5-10 years (because of subdued economic growth). And there are some really good companies trading at low valuations, particularly in the U.S. and Europe.
It doesn’t necessarily add up – low rates and low stock valuations don’t usually go together, nor do cheap stocks and subdued market expectations – but not to worry. What it really means is that there’s opportunity out there and we need to start culling through the negatives to find the positives. I say that not to cheer myself up, but rather to make sure we bring some balance to the discourse.