October 6, 2014
It's football season again and September and October are the most dangerous months for the stock markets. The crashes of 1929, 1987, and 2008 all began in those months. Does that have anything to do with football? No; but it does give me an opportunity to prove that correlations don't prove causation. That is what should come to mind whenever somebody impresses upon you the idea of "sell in May" or avoid "black October". That type of myopic thinking misses the big picture, which seems to be developing nicely.
As of this fall season, signs are pointing towards continued strength in the stock market. First of all, the U.S. economy seems to be doing quite well. The first quarter's GDP decline was the exception. The second quarter was very strong and it looks like we'll finish out that way, which will help companies increase revenue and earnings. Business investment and hiring are improving as well, though it's too early to tell if this is a trend. Second, the interest rate environment continues to make stocks look like very attractive long-term investments relative to bonds. Third, broad market valuations are not at the levels where we need to be afraid. The forward P/E (price-to-earnings) ratio of the S&P 500 is at 15.8, slightly above its long term average of 15. Fourth, energy prices are declining and manufacturing is coming back to the U.S. And finally, companies continue to return cash to investors through share buy-backs and dividend increases.
Yet, even though things are looking supportive, it is good to remember that corrections regularly happen in bull markets. Any number of foreseeable or unforeseeable events may create a little more excitement than we are comfortable with. I would note the geopolitical risks of the Middle East and Russia. There is also the Federal Reserve, whose bond purchases as part of their Quantitative Easing program will cease in October. Also worrisome is Japan's debt and currency situation.
However, over the past several years we've avoided any significant corrections partly as a result of investors waiting to get in on stocks and buying at the first hints of trouble. There is still a huge amount of cash out there waiting for a home. It seems unlikely to me that this phenomenon should suddenly fail to materialize and is therefore likely to continue to support equity prices in periods of fear and anxiety.
What is also noteworthy is that with the markets approximating average valuation levels, the easy money has been made. The days of everything rising in tandem are likely behind us. It is my opinion that in markets like this it is especially important to focus on valuation. I don't want to pick on Procter & Gamble, Co. (PG), but a P/E ratio above 21 for a company that's been able to grow their revenues at just 1.31% over the past five years is hard to justify. It's not cheap, so it's not a great value stock. And it's not growing. All across traditionally defensive sectors of the market, like utilities and consumer staples, things are as expensive as they've ever been. Other areas like industrials and technology, as well as many European companies, are downright cheap. There are excellent opportunities; you just have to dig to find them. For example, I would argue that Boeing Company (BA) is not the best way to play the growing global aerospace industry.
Putting markets and investing aside for a moment, I'd like to take an opportunity to try to shift our focus. We know that markets will ebb and flow, t 'was always so and t 'will always be thus. We have remarkably little ability to control those cycles. Yet we need to participate because it's a part of how we build and preserve our livelihoods. We should not let that ebb and flow interrupt our focus on the vastly more important parts of building and preserving our livelihoods, which are the basic, boring, daily disciplines of saving, budgeting, and planning. These activities are the foundation upon which we build our future. It makes no difference if you're ten years away from retirement or ten years into it; we all need to understand how to balance today's priorities with tomorrow's, for ourselves and for our families. These topics are not as sexy as the action of the capital markets and they do not make for lively dinner conversations. But, like any football coach will tell you, the 50-yard touchdown catch may make the highlight reels; it's the blocking and tackling that wins the game.
Brennan R. Redmond, CFA - Vice President
(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp. The author's opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities.)