Market Update 10.24.11

After a slew of it’s-really-bad-out-there market updates, here’s one with some significant positives. Listed below is the bullet point version of what’s looking up.

1. Historically, from now to year’s end has been a good time for stocks

2. There’s too much pessimism, and that means investors have fled stocks for the safety of cash . . . earning 0%*

3. Valuations are relative low, and dividends are relatively high (see * above)

Read on for all the details.

Market Update

With the situation in Europe still up in the air, it’s too soon to say the worst is over for stocks. The Europeans have one summit, follow it up with another, and then declare that a final answer will be provided at a third date. At each occasion, market participants hope that a solution will be forthcoming. Domestically, there are still concerns that low growth might turn into no growth, or negative growth; i.e. recession. Still, with October more than half over, the calendar becomes very friendly toward stocks. September has historically been the worst month, but October has had more memory-searing drops, like Black Monday in 1987.

The market’s action of the past few months did much to shake investor confidence. I’ve included below just two indicators that suggest the selling of August 9 was climactic, shaking out the weakest hands.

  1. Selling climaxes – these occur when a stock reaches a 52-week low but finishes the week with a gain. Recently, those skyrocketed, indicating that a lot of folks could take it no longer and sold at the bottom.
  2. Investor sentiment surveys – surveys of both professionals and individual investors show record high pessimism. Historically, these have marked market bottoms of various degrees.

•In addition, stock valuations are supportive. While stocks aren’t dirt cheap as a group, there certainly are groups of stocks where this is the case. As a group, valuations are reasonable. Dividends have been higher, but relative to interest rates, dividend yields are very high.

The pessimism is high from other angles, too. First, Citigroup maintains several Economic Surprise indexes. Those indexes track economists’ forecasts for economic indicators to what those indicators actually turn out to be. So, for example, each week economists publish their estimates for weekly claims for unemployment insurance. This week, for example, they’re forecasting 401,000 new claims will have been filed. If 395,000 claims are filed, the economists will have been too pessimistic; if 415,000 claims, then too optimistic. Citigroup charts that ongoing relationship, and for the U.S., since June 2, economists have been consistently too pessimistic. Here’s what that chart looks like.

 

In many ways, until just a couple of weeks ago, the market’s action felt worse than in early 2009, when everyone was nearly certain the world was about to end. Clients and others certainly radiated this feeling, with some saying the equivalent of—as one client did, “I think I’m going to take my toys and go home.” Do you count yourself among those? Don’t feel bad. The National Association of Active Investment Managers is an association of,

“registered investment advisors who provide active money management services to their clients, in order to produce favorable risk-adjusted returns.”

One thing NAAIM does is survey its members to, essentially, gauge their sentiment toward stocks. One thing its members do is FREAK OUT!  As you can see below, they recently registered their worst sentiment reading since late 2008.

 

With selling climaxes, sentiment surveys of individual investors, and anecdotal observations, one can make a strong case for a retail investor class that has fled from stocks in the short term. (On a longer-term basis, one could say that small investors have never returned to stocks, in that they report lower allocations to stock now than in 1999.) Throw in economists’ forecasts and the NAAIM survey and one can add in professional pessimism. Finally, the press continues to pipe a funeral dirge, as evidenced by another dandy cover story from The Economist, which is shown below—oh, my; this one’s a beauty!

Combine the calendar and pessimism toward stocks with progress in Europe—they’re saying the right things—and a better than expected corporate earnings season, and the fourth quarter could turn out to be a pretty good one. That leaves us feeling pretty good about stocks. Our key strategy services have yet to confirm this view with official shifts, but they seem to be leaning that way. If they do, we are likely to allocate more to stocks, less to bonds and cash, and to become more aggressive within equity portfolios.

Graig P. Stettner, CFA, CMT

Chief Investment Officer

Tower Private Advisors

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