From the Desk of Joe Rollins
I received several skeptical emails from clients in response to my July 2nd post, “Well, Who are You Gonna Believe, Me or Your Own Eyes?” In fact, one of my clients even questioned, “How can you be so optimistic when it is clear to everyone that the economy is falling into a depression!”
Some of my clients have been conveying a sense of desperation to me lately, which is likely a reflection of their frustration regarding the financial performance of their own assets. It’s clear that clients are growing more and more emotionally affected by the media’s reporting of the economy and the financial markets. The financial performance of the second quarter is a good example of how what the media reports is leading to investor frustration.
As I stated in my July 2nd blog, things aren’t nearly as dismal as the financial press would like for you to believe. The Department of Commerce recently announced that the national gross domestic product (GDP) for the 2nd quarter ended with an adjusted 3.3% gain – a percentage that seemed to utterly outrage the financial press. On many occasions I have heard analysts wonder how this adjusted percentage could be true.
The GDP was so strong in the 2nd quarter mostly due to the large export trade from this country principally to emerging markets. Even though the press would like for you to believe that our country is in a recession, the economy actually performed above standard.
The Federal Reserve has targeted a GDP growth of 2.5% to 3% annualized. If it’s true that the GDP grew at 3.3% in the 2nd quarter of 2008, then that growth level was clearly above trend. Interestingly, during the 2nd quarter of 2007 – only one year ago – the financial press was reporting our country to be in a state of economic bliss; we were in what is referred to as a “Goldilocks Economy” – it was neither too hot nor too cold, but just right.
The 2nd quarter GDP growth for 2007 was at 3.4%, which is just one-tenth of one percent higher than the performance reported for the 2nd quarter of 2008. Even though our economy’s performance was virtually the same during the second quarters of 2007 and 2008, the perception that it was so much worse in 2008 had more to do with what was being reported rather than what was actually happening.
As I argued in my July 2nd post, there’s no way that oil could realistically be priced at $148 per barrel. Exactly two months later, today oil is selling for $107 per barrel, or a decrease of 28%. It’s ludicrous for the media to argue that speculation isn’t a component of oil futures. It’s unreasonable for the price of oil to have risen 48% in the first half of 2008 and then turn down 27% in the last 60 days.
I heard a persuasive argument on a financial news program the other day that speculation is an integral part of investing. Speculation creates markets, and therefore, liquidity for investing. I’m a staunch believer that governmental intervention is almost always bad, but in this case, it’s different. Speculation in individual stock securities and most commodities doesn’t affect most people’s lives. The fact that the price of energy has gone up so dramatically not only affects everyday lives, it also impacts the national security here in the United States.
Even with the superior GDP results reported for the 2nd quarter of 2008, we’re still hearing from the naysayers. It usually goes something like this: “The GDP for the 2nd quarter was excellent, but…” What follows is inevitably a never-ending list of reasons why things aren’t looking so good for the future. The most common reason people speculate that growth will not be as good for the 3rd quarter of 2008 is because there weren’t any tax rebates released in the 3rd quarter. I guess a 27% reduction in price at the gas pump isn’t a financial rebate…
Many would argue that the economy is in a downward spiral, but the economic realities simply don’t agree with that argument. The economy is undoubtedly slow, but it’s certainly not negative.
That’s my take on the recent past, but here are some of my thoughts on what the future holds: I’ve commented in other posts about the inexpensive stock prices we’re seeing at the current time. I point this out while fully recognizing that the market seems to be drifting lower on a daily basis. Extraordinary volatility has entered the stock market, and it’s not unusual for us to see the market go up 200 points one day and down a corresponding amount the following day. It’s frustrating for everyone, but this is just part of the bottoming process.
There was an interesting article in the weekly financial magazine, Barron’s, this past weekend entitled, “The Reluctant Bulls.” Barron’s surveyed nine strategists and chief investment officers, and I thought their projections were quite interesting. Overall, they forecasted an average increase in the market at this year’s end to be a meager 5%. Since this was an average forecast of those surveyed, obviously some of the strategists predicted a higher increase while others had lower predictions. Of course, you can get many different projections on Wall Street depending on the number of strategists you survey.
In any event, I found it most compelling that regardless of whether the strategists predicted small gains from September through December, “…almost all see very limited further downside for a stock market that has already fallen 11% in 2008 and 16% from its October 2007 peak.” This is remarkably meaningful; maybe the stock market bottom that Jim Cramer described and that I talked about in my “Many Reasons for Optimism” post is actually beginning!
I’ve discussed before how the Federal Reserve calculates fair market value for the stock market. Basically, next year’s operating earnings for an index are divided by the 10-year Treasury rate. The consensus estimates for operating earnings for 2009 on the S&P 500 is $75. The current yield on a 10-year Treasury bond is 3.8%, generating an estimated fair market value on the S&P 500 at 1,974. The current level of the S&P 500 is 1,285 and based on this calculation, the S&P 500 today is 50% undervalued.
The stock market is a forward-projecting barometer; while the past is important, the future has primary influence. How many times have you heard in recent months that the real estate recovery will not occur until 2009? I know it’s hard to believe, but 2009 is only four months away. Additionally, the Federal Reserve has already taken swift and dramatic actions to improve the economy into the future. Our Federal Funds Rate now stands at 2% – one of the lowest in the developed world – which has already begun to positively impact the consumer.
Many credit cards are tied to the prime rate of interest, and have correspondingly been dramatically reduced with this decrease in the prime rate of interest. The significant reduction in the cost of gas is already adding to consumers’ ability to continue to spend. Low interest rates have continued to make mortgages cheap to consumers, and new Federal incentives have made home buying less expensive and more accessible than ever. Notwithstanding what you hear on the various news channels, the progress on the economy is encouraging.
The U.S. has been very proactive in improving its economy, and as is typically the case, the socialist European countries have failed to react. It is now believed that almost all of Europe has fallen into a recession. Likewise, it’s clear that Japan has now moved into a recession. Even though Europe’s economy has stalled, the EU begrudgingly keeps interest rates high at 4.25%. Compare that to the U.S. rate of 2% and you can see that the U.S. has already moved to bail out the economy. Although Asia’s economy has clearly slowed, it continues to have the highest growth rate in the world. Therefore, at the current time the U.S. economy is recovering and Asia continues to outperform.
I think we’ll see the stock market performing much better over the next six months – certainly better than we’ve seen over the last six months. It wouldn’t surprise me to see performance through the end of 2008 that will essentially make us close to break-even for the year. While break-even performance isn’t great, given that we’ve made close to 100% compounded for the period from 2003 through 2007, I think it’s predictable and acceptable for us to perform at a break-even level this year. It’s just not realistic to anticipate performing in the double-digits every single year.
There are three major asset classes, and currently, two of the three are enduring very poor returns. If you have cash in a money market account, then you’re probably earning less than 2% annualized. Even with a 10-year Treasury bond, you’re only making 3.8% annually. Arguably, both of these rates are providing negative real rates of returns when you consider the current rate of inflation.
Over the next 12 months, it wouldn’t take much for stocks to significantly outperform the other two major asset classes. In fact, you can easily find stocks today that have dividend rates of return double those of a money market account that are growing 7% or 8% annually. I can assure you that stocks haven’t been this cheap in the time since I became an investment manager.
Even though the Asian and oil stocks have been clobbered in the market over the last few months, they continue to offer extraordinary value. The Chinese and other Asian stocks have sold off dramatically, assuming a major pullback in their economies. Although oil is down significantly, oil companies continue to return extraordinary and unheard of profits. While they are volatile and down, we believe that Asian stocks, the emerging market stocks (which principally represent oil) and the oil stocks themselves offer unique and potentially rewarding returns for the next 12 months.
I think we’ve established a base in the current stock market that will allow future years to greatly outperform 2008. The U.S. economy, while not strong, is still firmly positioned for good performance into the future.
I received several skeptical emails from clients in response to my July 2nd post, “Well, Who are You Gonna Believe, Me or Your Own Eyes?” In fact, one of my clients even questioned, “How can you be so optimistic when it is clear to everyone that the economy is falling into a depression!”
Some of my clients have been conveying a sense of desperation to me lately, which is likely a reflection of their frustration regarding the financial performance of their own assets. It’s clear that clients are growing more and more emotionally affected by the media’s reporting of the economy and the financial markets. The financial performance of the second quarter is a good example of how what the media reports is leading to investor frustration.
As I stated in my July 2nd blog, things aren’t nearly as dismal as the financial press would like for you to believe. The Department of Commerce recently announced that the national gross domestic product (GDP) for the 2nd quarter ended with an adjusted 3.3% gain – a percentage that seemed to utterly outrage the financial press. On many occasions I have heard analysts wonder how this adjusted percentage could be true.
The GDP was so strong in the 2nd quarter mostly due to the large export trade from this country principally to emerging markets. Even though the press would like for you to believe that our country is in a recession, the economy actually performed above standard.
The Federal Reserve has targeted a GDP growth of 2.5% to 3% annualized. If it’s true that the GDP grew at 3.3% in the 2nd quarter of 2008, then that growth level was clearly above trend. Interestingly, during the 2nd quarter of 2007 – only one year ago – the financial press was reporting our country to be in a state of economic bliss; we were in what is referred to as a “Goldilocks Economy” – it was neither too hot nor too cold, but just right.
The 2nd quarter GDP growth for 2007 was at 3.4%, which is just one-tenth of one percent higher than the performance reported for the 2nd quarter of 2008. Even though our economy’s performance was virtually the same during the second quarters of 2007 and 2008, the perception that it was so much worse in 2008 had more to do with what was being reported rather than what was actually happening.
As I argued in my July 2nd post, there’s no way that oil could realistically be priced at $148 per barrel. Exactly two months later, today oil is selling for $107 per barrel, or a decrease of 28%. It’s ludicrous for the media to argue that speculation isn’t a component of oil futures. It’s unreasonable for the price of oil to have risen 48% in the first half of 2008 and then turn down 27% in the last 60 days.
I heard a persuasive argument on a financial news program the other day that speculation is an integral part of investing. Speculation creates markets, and therefore, liquidity for investing. I’m a staunch believer that governmental intervention is almost always bad, but in this case, it’s different. Speculation in individual stock securities and most commodities doesn’t affect most people’s lives. The fact that the price of energy has gone up so dramatically not only affects everyday lives, it also impacts the national security here in the United States.
Even with the superior GDP results reported for the 2nd quarter of 2008, we’re still hearing from the naysayers. It usually goes something like this: “The GDP for the 2nd quarter was excellent, but…” What follows is inevitably a never-ending list of reasons why things aren’t looking so good for the future. The most common reason people speculate that growth will not be as good for the 3rd quarter of 2008 is because there weren’t any tax rebates released in the 3rd quarter. I guess a 27% reduction in price at the gas pump isn’t a financial rebate…
Many would argue that the economy is in a downward spiral, but the economic realities simply don’t agree with that argument. The economy is undoubtedly slow, but it’s certainly not negative.
That’s my take on the recent past, but here are some of my thoughts on what the future holds: I’ve commented in other posts about the inexpensive stock prices we’re seeing at the current time. I point this out while fully recognizing that the market seems to be drifting lower on a daily basis. Extraordinary volatility has entered the stock market, and it’s not unusual for us to see the market go up 200 points one day and down a corresponding amount the following day. It’s frustrating for everyone, but this is just part of the bottoming process.
There was an interesting article in the weekly financial magazine, Barron’s, this past weekend entitled, “The Reluctant Bulls.” Barron’s surveyed nine strategists and chief investment officers, and I thought their projections were quite interesting. Overall, they forecasted an average increase in the market at this year’s end to be a meager 5%. Since this was an average forecast of those surveyed, obviously some of the strategists predicted a higher increase while others had lower predictions. Of course, you can get many different projections on Wall Street depending on the number of strategists you survey.
In any event, I found it most compelling that regardless of whether the strategists predicted small gains from September through December, “…almost all see very limited further downside for a stock market that has already fallen 11% in 2008 and 16% from its October 2007 peak.” This is remarkably meaningful; maybe the stock market bottom that Jim Cramer described and that I talked about in my “Many Reasons for Optimism” post is actually beginning!
I’ve discussed before how the Federal Reserve calculates fair market value for the stock market. Basically, next year’s operating earnings for an index are divided by the 10-year Treasury rate. The consensus estimates for operating earnings for 2009 on the S&P 500 is $75. The current yield on a 10-year Treasury bond is 3.8%, generating an estimated fair market value on the S&P 500 at 1,974. The current level of the S&P 500 is 1,285 and based on this calculation, the S&P 500 today is 50% undervalued.
The stock market is a forward-projecting barometer; while the past is important, the future has primary influence. How many times have you heard in recent months that the real estate recovery will not occur until 2009? I know it’s hard to believe, but 2009 is only four months away. Additionally, the Federal Reserve has already taken swift and dramatic actions to improve the economy into the future. Our Federal Funds Rate now stands at 2% – one of the lowest in the developed world – which has already begun to positively impact the consumer.
Many credit cards are tied to the prime rate of interest, and have correspondingly been dramatically reduced with this decrease in the prime rate of interest. The significant reduction in the cost of gas is already adding to consumers’ ability to continue to spend. Low interest rates have continued to make mortgages cheap to consumers, and new Federal incentives have made home buying less expensive and more accessible than ever. Notwithstanding what you hear on the various news channels, the progress on the economy is encouraging.
The U.S. has been very proactive in improving its economy, and as is typically the case, the socialist European countries have failed to react. It is now believed that almost all of Europe has fallen into a recession. Likewise, it’s clear that Japan has now moved into a recession. Even though Europe’s economy has stalled, the EU begrudgingly keeps interest rates high at 4.25%. Compare that to the U.S. rate of 2% and you can see that the U.S. has already moved to bail out the economy. Although Asia’s economy has clearly slowed, it continues to have the highest growth rate in the world. Therefore, at the current time the U.S. economy is recovering and Asia continues to outperform.
I think we’ll see the stock market performing much better over the next six months – certainly better than we’ve seen over the last six months. It wouldn’t surprise me to see performance through the end of 2008 that will essentially make us close to break-even for the year. While break-even performance isn’t great, given that we’ve made close to 100% compounded for the period from 2003 through 2007, I think it’s predictable and acceptable for us to perform at a break-even level this year. It’s just not realistic to anticipate performing in the double-digits every single year.
There are three major asset classes, and currently, two of the three are enduring very poor returns. If you have cash in a money market account, then you’re probably earning less than 2% annualized. Even with a 10-year Treasury bond, you’re only making 3.8% annually. Arguably, both of these rates are providing negative real rates of returns when you consider the current rate of inflation.
Over the next 12 months, it wouldn’t take much for stocks to significantly outperform the other two major asset classes. In fact, you can easily find stocks today that have dividend rates of return double those of a money market account that are growing 7% or 8% annually. I can assure you that stocks haven’t been this cheap in the time since I became an investment manager.
Even though the Asian and oil stocks have been clobbered in the market over the last few months, they continue to offer extraordinary value. The Chinese and other Asian stocks have sold off dramatically, assuming a major pullback in their economies. Although oil is down significantly, oil companies continue to return extraordinary and unheard of profits. While they are volatile and down, we believe that Asian stocks, the emerging market stocks (which principally represent oil) and the oil stocks themselves offer unique and potentially rewarding returns for the next 12 months.
I think we’ve established a base in the current stock market that will allow future years to greatly outperform 2008. The U.S. economy, while not strong, is still firmly positioned for good performance into the future.
