The Power of Hope Works
Given all this, we would be all well advised to follow the admonition of Mervyn King. Last month, the
governor of the Bank of England stated bluntly: “It’s the level, stupid – it’s not the growth rates, it’s the levels
that matter here.” Investors have not yet accepted his insight that the absolute levels of income, debt, wealth
and unemployment, not just the rates of change, are what matter today.
They need to, and soon.
Mohamed El-Erian, CEO, PIMCO
(see full Viewpoint at www.pimco.com)
We have been sharing our belief for some time now with clients
and readers of our letters that the fundamentals of this stock
market simply do not support the levels to which its averages
David Rosenberg, respected chief economist and strategist at
Gluskin Sheff & Associates, points out in a recent Financial Times
article that the market only became fairly priced when it hit its
low point in March of this year.
Usually at bear market troughs, he said, the S&P 500 goes to
embarrassingly cheap levels. It did not this time. We are now 6
months into a rally that has lifted the S&P by 60% - to a level
that is priced for forward-looking GDP growth which is already
twice as great as what we can reasonably expect.
Price-earnings ratios, a measure of market valuation, increased
since March by an unprecedented 8 points. By historic measures
of valuation, the market is now about 4 times overvalued.
History tells us, per Rosenberg, that total return a year following
a run up of this nature turns negative 60% of the time.
His conclusion is that there is too much growth and too much
risk embedded in the equity market right now. And history
A Faith-Based Rally?
A definition of “miracle” comes to mind. In defiance of the
principle of cause and effect, a miracle occurs when an effect
manifests that has no discernable cause.
We look at the market’s rise since March and we look for a
discernable cause. Failing to find a good answer, we ask how
long can a market rally be sustained based on the faith that the
economy will eventually catch up?
It feels to us like this market is being propelled forward by the
power of hope.
What to Do?
We continue to look for signs. Third Quarter earnings reports
are coming out in early October. Will Corporate America report
real profitability, or will their cost cutting measures and the
effect of early government stimulus measures again be
responsible for positive results?
Currently, we know there is significant liquidity sitting on the
sidelines. Some of that money may find its way into the stock
market. If economic indicators remain stable, or decline less
than they did six months ago, that liquidity could propel the
stock market a bit further.
We’re all for a continued rise in the stock markets. In fact, there
is a case for rising expectations. However, any future optimism
on our part toward a sustained market rise rests on seeing more
rapid improvement in the underlying economic fundamentals.
Give us more objectively quantifiable data before asking us to
make any leaps of faith.
The new investment opportunities we will be adopting will be
based on the amount of risk we believe each one poses in this
environment. We may indeed decide to supplement our asset
allocations with some stock market exposure and other asset
classes that offer a good risk/reward ratio.
Whatever equity exposure Silver Oak may decide to take will be
well cushioned against extreme volatility with the types of
vehicles that have kept our portfolios profitable over the entirety
of the last 12 months.
We don’t believe in miracles, and our faith in the power of hope
Best personal regards,