Last month we investigated whether the ‘cult of equity investing’ had died and if it would ever return.  While many of the traditional valuation measures for stocks don’t appear to have much impact at the moment, we continue to see the potential for substantial long-term gains in stock prices being set up by the worries about the global economy and the excessive fears about a collapse of the global financial system.  Unless the global economy is about to head into a major downturn (which we sincerely doubt) then stocks are trading at levels that will generated substantial gains over the next 3-5 year period.  Moreover, with interest rates at all-time lows, we don’t think that investors fully appreciate the risk in holding bonds or other income-related investments.  We have increased our stock market exposure in our managed funds during the recent downturn in prices and we outline our rationale for this move.  We have added cyclical stock exposure as valuations are extremely attractive in industries such as Energy (particularly oil service stocks) and Basic Materials (gold, base metals and agricultural stocks are all trading at long-term lows in terms of valuation).  Aggressive liquidation of portfolios by foreign investors, hedge funds and some domestic players are reminiscent of the ‘Lehman-like’ panic selling that we saw in the fall of 2008 and have created similar buying opportunities in many well-funded junior resource stocks.  Recall that many of those stocks then experienced doubles and triples over the ensuing recovery period.  A sampling of such names we see now includes Legacy Oil and Gas, Crew Energy, Athabaska Oil Sands, Trinidad Drilling, Capstone Mining, Kinross Gold, Osisko Mining and Uranium One.

While Technology stocks continue to look good for the long-term, earnings growth will moderate over the next few quarters due to the European situation and reticence by corporations to spend aggressively.  However, valuations for the major international players such as Microsoft, Google, Apple, Qualcomm, Broadcomm and Cisco are all basically at all-time lows, suggesting upside from both earnings growth and valuation improvements.  U.S. financial stocks are also under-valued and are finally starting to see earnings improve as the US housing market stabilizes and bank capital ratios reach more comfortable levels.  Banks are also scaling back capital markets exposure, which should reduce earnings volatility going forward.  We have recently added to positions in JP Morgan, Bank of America and CitiGroup in the portfolios we manage.

Stocks have effectively  been doing nothing for more than 12 years now as investors vacillate between periods of economic expansion and stock market growth (2003-07 and the 2009-2010) and periodic sharp downturns (tech bear market 2000-2002, financial crisis in 2008 and the recent downturns in the spring of 2011 and again this year).  This pattern is shown in the chart below which tracks the movement of the S&P500 index right back to 1929.  Stocks have been shown to go through these periods of ‘shorter booms and busts’ which ultimately set up for longer-term stock market gains as we saw in the 1950’s/60’s and again in the 1980’s/90’s.  While the periods when markets vacillated were marked by more political strife and higher inflation from events such as the Vietnam War and the oil embargoes of the early 1970s, the stronger long-term gains were driven by expanding economies and strong profit growth.  While there are no guarantees that we are about to turn the corner into a period of extended economic growth, the sheer volume of pessimism about the outlook for the global economy and stock markets have convinced us that we are definitely in the process of creating one of the great buying opportunities that most stock investors will see for a long time.

Stocks Building a Base to Move Higher

There is never a shortage of potential bad news if that’s what investors want to focus on.  Even before the great bull market of the 1990’s began, there were huge fears about the U.S. real estate market and how a downturn in Japan would lead to even further selling and carnage.  Of course that never did come about, but it shows how there will always be worries.  Today those fears are clearly focused on Europe and their ability to cope with a political and economic system that relies on the co-operation of 17 different governments and cultures of people who are faced with slowing growth, excessive debt and no easy way out.  Add to that the fear that China, the world’s second largest economy and the clear leader of growth over the past decade in the global economy, is slowing down and that the ‘Chinese economic miracle’ might be closer to the end.  Finally, the U.S., which had been the engine of growth in prior cycles and has been the strongest part of the global economy over the past year, is losing some economic momentum as the year wears on.  So where is the impetus to be a buyer in the midst of all of this?

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