Bartlett Commentaries
Market Commentary, 01 / 2009
Investors are an interesting group: they don’t apply the same purchasing logic to financial assets that they use for other goods. Lower prices do not encourage them to buy as in the purchase of electronics or furniture; in fact, investors lose confidence when financial asset prices are declining. Investors tend to invest in the market when prices have gone up, not down. This seems particularly germane given the mindset of many investors, particularly if they have been tuning into the lion’s share of the investment programs on radio or TV. Unfortunately, viewership seems more willing to listen to gloom and doom messages or, in any case, it seems to be an easier sell for the media to prophesy disaster.
In the United States, the S&P 500 Index declined by thirty-seven percent, the worst showing for common stocks since 1931. The month of October, in fact, was the worst monthly decline ever for the S&P 500, while September was the eighth worst month for the stock market since 1950. Adding insult to injury, the market declined by another seven percent in November.
The overseas markets provided no refuge. The only markets that outperformed the U.S. markets, as measured in U.S. dollars, were Japan, which was down twenty-nine percent, and Switzerland, which declined by thirty-one percent.
The fixed income markets, normally a safe haven in times of distress, were safe only if one confined the portfolio to Treasury and government agency and very high quality corporate bonds. The past year was disastrous for high yield bonds, convertible bonds, and preferred securities. Mutual funds that specialized in these investments posted declines of twenty percent or greater.
Notwithstanding a difficult economic situation, we think long-term investors should maintain holdings of high quality stocks and bonds, while remaining on the lookout for good buying opportunities.
- Stocks are the quintessential “leading indicator” because they usually bottom three to six months before a recession’s end. The recession is now in its thirteenth month, and will almost certainly eclipse the postwar record of sixteen months (1974 and 1982). Nevertheless, monetary officials here and abroad have been lowering interest rates and fiscal stimulus is on tap as well, so improvement seems likely. Even if the economy does not bottom until late 2009, a meaningful market recovery could begin by Spring.
- High quality stocks are attractively valued, with moderate price/earnings multiples of ten to fifteen. Moreover, many have secure and growing dividend yields that are competitive with US Treasury and high-grade corporate bond yields. The pervasive market decline experienced in 2008 has given rise to opportunities across the equity spectrum, in almost all sectors and throughout the world.
- Sentiment statistics are encouraging. These measures are contrary in nature: indicators of extreme optimism usually occur near market peaks and should be regarded cautiously, while extreme pessimism is usually evident near market bottoms. The latest Barron’s cited data from the Investment Company Institute showing that “the amount of money stashed in money-market mutual funds had surpassed that in stock mutual funds as of the end of November.” This is indeed a remarkable circumstance; it indicates an extraordinary level of buying power that could propel markets if and when confidence begins to improve.
- Investment-grade corporate and municipal bonds are attractively priced. Yield spreads (the difference in yield between Treasury bonds and other bonds) are very wide by historical standards. These more conservative securities are a solid compliment for stocks within balanced portfolios.
Large capitalization U.S. common stocks have generated an annualized return of 9.3 percent since 1925. Given that stocks were reasonably valued in the beginning of October, 2007, and that the market declined by forty percent during the ensuing fifteen month period, one could postulate that the market will have some very good years over the next four years, so that the market reverts to a 9.3 percent annualized return on a go-forward basis from October, 2007. In fact, for there to be a 9.3 percent annualized return for the five year period beginning October 1, 2007 and ending September 30, 2012, common stocks would have to generate a twenty-eight percent annualized return for the next four years. While we would not forecast such a favorable set of circumstances, there is good reason to believe that the returns over the next four years will average better than 9.3 percent per annum.
Of course, the world’s economic situation is not without serious problems, to put it lightly. An economic recovery may be delayed if, for instance, the credit markets don’t thaw. If the recipients of distributions from TARP, the $700 billion rescue fund, sit on the funds, the recovery will be delayed. Then, a longer-term concern is that the reputation of free market capitalism has been tainted by excesses in the financial markets. Also, increased regulation, although necessary, can present a headwind for long-term growth. Unfortunately, we are seeing firsthand what the absence of regulation can create.
We are mindful of the fact that even modest returns for stocks and bonds would exceed the negligible returns available from eminently safe investments such as Treasury notes. Unfortunately, Treasury bills have no yield and Treasury notes have less than a three percent return. Adjusted for inflation, and taxes, if one is a taxable investor, Treasury and U.S. government agency obligations are not viable investment media at this time. Overall, however, diversification in the common stock component of your portfolio is imperative.
Common stocks are oversold at this time. When forty percent or less of institutional investors are bullish, that is a positive sign for the market. Considering the latest bullish sentiment indicator is at twenty-four percent, there is reason for optimism. Combine this with the buying power of money socked away in money market mutual funds perhaps waiting to enter the common stock markets and there may be even more reason to be optimistic about the future of common stock prices.
For more information on this topic, please contact us. At Bartlett & Co, we assist high net worth individuals and their families in defining & reaching their life goals.