Recently, I have been reviewing the historical files of several of our oldest family client relationships. I am looking for hints to determine what people thought of market tops during past recoveries. It is one thing to read about history after it has been refined through 20/20 look back glasses where historians describe what now appear to be obvious reasons for past events. It is another thing to live through the events as they occur with all the uncertainty what the future will unfold.
One of the most fascinating books I have read recently is, The Great Depression. It is a day-by-day diary of the Depression period written by a Youngstown, Ohio attorney. The views expressed by the writer are real and reflect the concerns of the time, as they were happening. It is much different than the refined, perfectly explained cause and effect account reflected in most history books. The writer describes real fears, doubts and disappointments that caused so much concern at the time. When the recovery started no one believed it would last.
As I read some of the notes in our own client meetings from as far back as 1945, and as recent as last week, one thought surfaced every time the market reached a milestone such as a new high of the DOW. One question continued to be asked, “Is this the top?”. This occurred at DOW 100, DOW 1,000, DOW 10,000 and many other self-defined “tops”. And, in each occasion, there were numerous reasons as to why the market would collapse at any minute. Few, if any, talked of continued growth and recovery.
There was a consistency in the discussions and questions. Pessimism ran strong after a market correction to the extreme point of fear, total loss. Even after the economy showed recovery strength and a nice slow move to the upside, investors manufactured doubt. There was always something that wasn’t perfect. Many times the doubt keep them from investing in the market and supported highly defensive investment positions. Not until the stock market recovery was well underway did these doubtful investors have the courage to move back into the stock market. By that time much of the stock market recovery was in the rear view mirror.
Today I hear many investment advisors tell of great corrections using the favorite term of the day, “bubble”. Everything today has to be a bubble. Ever since the mortgage revaluation crisis of 2008 was described as a bubble it has become the replacement for “perfect storm”. Why do writers and commentators believe their view will be better accepted if they use recent catchy phrases?
Let us look at some of the facts in an attempt to reach an objective view. The market is well into a recovery from the depths of 2008; that is a given. The market has now moved past the heights achieved prior to the most recent correction labeled the Great Recession. The current recovery has established new highs. The doom forecasts are in full gear and bubbles are everywhere. I am not so sure.
By our straight forward calculations, the market is currently trading at 6% above fair value or 106%. That is well below the beginning of overvaluation which occurs at 130%. Additionally, seven of the 10 domestic sectors that comprise the market are within one percentage point of their fair value. Only Healthcare is overvalued by a sizable amount, 2 percentage points and energy is undervalued by over 3 percentage points primarily due to an energy pricing scare. By all measures, the market is fairly valued. The recovery is not being driven by a single area of the market in isolation.
Energy is undervalued because earlier investors thought lower oil prices would create a depressed capital expenditure environment resulting in lower earnings. I believe this view is short term because capital expenditures that are eliminated is one thing, delayed expenditures are an entirely different scenario. Almost all of the capital expenditures were delayed, not eliminated and have been simply moved out 12 to 24 months. Energy demand is still on track and supply needs to adjust through reduced capital expenditures. Done.
Additionally, the consumer just received a raise through lower energy prices so that they can lower debt and/or increase spending and saving. Consumers are saving. On balance lower energy prices may be a neutral factor at this junction in the recovery. Everything else is remaining on the slow and boring recovery.
Future expected earnings are certainly looking favorable for this year and next. At current expectation rates there will be a 35% increase in overall earnings for the next 12 months. This is sizable and probably overly optimistic but, well within a range to potentially fuel a continued recovery. I think this recovery is like many previous recoveries. I believe it has a high probability to defy doomsayer’s predictions and continue on the path of slow overall upward movement. Can we reach 20,000? Possibly, overvaluation kicks in at 21,684 and caution starts to set in at 20,016. If earnings continue to improve this number could possibly move higher over time.
Much is in play at this point including a low US$ but, that may actually be a great long-term benefit. If the Euro weakens or stays within the current range, European products will receive a boost on the global markets. If Europe recovers it will add to the American economy through increased demand. It will also bring about higher demand generated through GDP and maybe even an improved Greek economy. Many factors can impact the recovery positively and negatively, but for now I think the doomsayers are early, very early.