Don’t Confuse Local Economics with Markets
Do investors (and the press) confuse the economy with the stock market? Although the economy expands and contracts and stocks rise and fall; they often seem out of synch. Moreover, those that invest in response to anecdotal stories or news headlines or market trends may be doomed to fall short of achieving their investment objectives. Take a look back at the last twenty years investment returns for a wide range of assets depicted in Figure 1 below.
20 Year Sector Returns 1989-2009 (Figure 1)
Why does the average investor lag the higher returning alternatives? They tend to buy stocks when they feel they are “safe” (prices are trending up) and they typically sell them when they think the markets are “too risky” (prices are trending down or very volatile). Behavioral scientists dub this “projection bias”, a response driven by the “recency effect” which extrapolates current experience into future expectations. Emotions too often dictate our investment compass. This is a natural tendency but one that needs to be overcome. We need to keep our long term objectives in mind and resist the temptation to let headlines and emotions drive investment decisions. Investing over time, with our emotions in check and without being too greedy or too gun shy, should continue to serve us well.
3Q Reversal Three months ago, the markets seemed dangerous post the Euro crisis induced May and June swoon in the equity markets as fears of a double dip led investors to sell stocks. Equity markets (as measured by the S&P 500) turned back up in July (+7.6%) as modest but steady U.S. private employment creation continued and better than expected second quarter earnings were reported. Stocks gave back 7% in August before rallying 12% in September. Can you say “whiplash”? For the quarter, the S&P 500 index rose 10.7%, rebounding strongly from its 2Q10 -11.9% and bringing the YTD S&P gain to 2.3%. What is going on?
Earnings and valuation remain attractive. Second quarter earnings for S&P 500 companies again beat Wall Street’s expectations. Similar to 1Q10, positive earnings surprises for this group were ahead of negative ones by 4.5:1. In other words, for every company that reported weaker than expected earnings, 4 ½ companies reported stronger than expected results. How can this be? Isn’t the economy weak? Although the economic recovery remains relatively weak, large corporate earnings are robust and balance sheets are strong. Large corporate America sells as roughly 40% of its sales overseas. Smaller, local firms don’t. Our tendency is to look around and see our neighbor’s business that is down 50% of from its (strong) peak and draw negative conclusions. We are less likely to chat with the Fortune 500 CEO whose firm is experiencing better results. That said U.S. consumer demand will remain tepid until employment growth improves. Negative political rhetoric will also probably escalate ahead of the U.S. midterm November elections. Corporate earnings estimates for 2011 may be cut and the third quarter rebound in stocks (on relatively low volume) is not guaranteed to hold. Furthermore, U.S. banks have yet to close or shrink their proprietary trading desks and their wind down could (temporarily) pressure markets. However, the rebound in stock prices could well reflect expectations for continued earnings growth in the near term and in 2011. While we envision volatility in stock prices will continue through year end, current equity valuations remain below historical averages and together with continued earnings growth render equities attractive.
The only sure way to grow wealth is to spend less than you make and save/invest the difference but how one invests can and does make a big difference. We will continue to consider economic, market, political, and investor developments to draw actionable tactics to help our clients achieve their investment goals. As always we will endeavor to deliver competitive returns with below average risk, thus being effective stewards of your money.
Thank you for your continued trust in Regency Wealth Management.
Mark D. Reitsma, CFP®, CMFC Andrew M. Aran, CFA
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.