Stock swoon fills the sidelines
(St. Louis Post Dispatch)
John Meara, president of Argent Capital Management in Clayton, swears by the “rule of 20.” Subtract the 10-year Treasury bond interest rate from 20. The result is the fair price/earnings ratio for stocks. Right now, the rule of 20 would put the P/E at 17.
As of Friday, the P/E on the S&P 500 was 14.8 for trailing earnings and 13.5 for 2010 earnings. The long-term historical average is 16. All of that signals a buying opportunity.
“Once people come out of their bunkers, they’ll look around and say, ‘This is ridiculous,'” said Meara.
July 4, 2010
The stock market is in a deep funk as investors wring their hands over the financial mess in Europe and an American economy that can’t get traction.
The stock market is down 8.3 percent for the year, and it’s still 35 percent below its 2007 high. Bond yields are too teeny to be tempting.
So, is Wall Street’s May-June swoon a chance to buy cheap stocks or a warning that another asset-devouring trauma is around the corner? Or is it the prelude to a long, slow, unprofitable 1970s-style slog down an investment road to nowhere?
The uncertainty has lots of investors sitting on the sidelines. Others have developed a taste for dividend-paying stocks, on the theory that a 5 or 6 percent payout should ease the pain if the market keeps heading south.
The bulls look at corporate profits and see a bright buy signal. Stock analysts spent June ratcheting down their earnings estimates to take account of European banking and debt worries. But even the lowered estimates are sweet. The consensus calls for a 25 percent boost in profits for big American companies over the next 12 months, according to Bloomberg.
“Underlying all these worries, the economy is slowly improving and companies are reporting solid earnings,” said Kate Warne, investment strategist at Edward Jones in Des Peres. That bodes well for stock prices, she says.
Across town, Wells Fargo Advisors is predicting that the S&P 500 index of big-company stocks will end the year at 1,100 to 1,140. It closed Friday at 1,022, its lowest close since September.
“We think the market is in a trough, not a waterfall,” said Mark Keller, CEO at Confluence Investment Management in Webster Groves.
Indeed, stocks do look cheap if you compare them to corporate earnings and the low interest rates being paid on bonds. A 10-year Treasury bond is yielding only 2.98 percent.
John Meara, president of Argent Capital Management in Clayton, swears by the “rule of 20.” Subtract the 10-year Treasury bond interest rate from 20. The result is the fair price/earnings ratio for stocks. Right now, the rule of 20 would put the P/E at 17.
As of Friday, the P/E on the S&P 500 was 14.8 for trailing earnings and 13.5 for 2010 earnings. The long-term historical average is 16. All of that signals a buying opportunity.
“Once people come out of their bunkers, they’ll look around and say, ‘This is ridiculous,'” said Meara.
So, why aren’t investors buying?
They remember the great crash of 2008 and 2009, when half the value of the stock market disappeared. “They’re scared to death that that’s what’s happening again,” said Keller. “Your patience is tried at the extremes. When you’re at the low end, it’s easy to be fearful.”
WOBBLY RECOVERY
There is certainly reason for fear.
Today’s corporate earnings come from vicious cost-cutting. Companies spent last year chopping employees and piling up cash. To take profits further, they’ll have to see growth in sales. That growth is coming — but slowly.
Consumer spending, which drives two thirds of the economy, is growing at a slow-poke rate of about 2 percent. Unemployment has consumers scared, so they’re socking away savings, putting 4 percent of their paychecks in the piggy bank, up from zero when the good times were rolling earlier in the decade. Conference Board’s consumer confidence index dropped nearly 10 points in June to a morose 52.9.
That leaves corporate and government spending to push the recovery along. Corporations are stepping up, buying new equipment and software, with capital spending up 18 percent in May from a year earlier.
Government spending is a mixed bag. Uncle Sam is still writing checks on the $787 billion stimulus package passed last year. But Congress is getting stingier. Frightened by this year’s $1.6 trillion deficit, lawmakers last month refused to extend unemployment insurance to 1.3 million long-term jobless, despite an unemployment rate of 9.5 percent.
Europe has declared austerity, cutting public spending and payrolls. That may save nations such as Greece from default and avoid a trillion-euro bailout of the European banking system, but it will slow the European economy to a crawl — and crimp profits for U.S. exporters and multinationals.
Analysts generally think the effect on American investors should be muted. “Europe is just not as important as it used to be. The emerging markets are now more than 50 percent of world GDP,” said Meara of Argent Capital.
Still, it’s bad news for investors. European stock funds in America are down 13 percent so far this year, compared to a 8.4 percent loss for worldwide funds and a 6.4 percent dip for emerging markets funds, according to Morningstar.
Warne, the Edward Jones strategist, thinks the new-found fiscal rectitude is one reason the markets are spooked. In the long run, big deficits can bring real economic troubles, including inflation. But in the short run, deficits help end recessions by getting people working and spending.
All of that is fanning worries about a double-dip recession. The vast majority of economists don’t think it will happen.
The Wall Street Journal’s latest poll of economists shows a consensus forecast of 3 percent growth for the rest of the year. That should bring unemployment down from May’s 9.7 percent to 8.6 percent by the end of next year.
A jobless rate that high means consumers will keep their funk. Keller, of Confluence Asset Management, thinks we’re stuck in a secular bear market. Stocks will go up for a while, and down for a while, but in the long run they end up about where they started, he said.
Such pessimists still think there’s money to be made in stocks, but they want a dividend to ease the downside risk.
INVEST WHERE?
Money-manager Joe Terril likes phone companies AT&T and Verizon, both of which yield nearly 7 percent.
His bet is that growth in wireless and Internet communication will trump the slow fade of their traditional land-line phone business.”They own the backbone that makes the Internet work,” he said.
Terril also likes pipeline and energy storage companies, which also pay big dividends. Some are structured as master limited partnerships. They don’t own the fuels, so they’re not affected by oil prices, Terril notes.
“As long as the country uses the same amount of fuel, the meter ticks at the same rate,” he said. He likes Kinder Morgan Energy Trust (Ticker KMP) and Sunoco Logistics (SXL). They yield 6 to 7 percent.
The companies have a habit of raising dividends, which should help protect the share price when interest rates finally start to rise.
Kelly Sullivan, president of financial adviser DunckerStreett in Clayton, adds Enbridge Energy (EEP), Magellan Midstream (MMP) and Spectra Energy (SEP) to the list.
Dividend stocks, like bonds, suffer when interest rates rise. That will happen eventually, but not quite yet. The consensus among economists calls for the Fed to begin tightening rates next March, and they’ve been pushing that date back.
Keller says electrical utilities, known for their dividends, are starting to look good again, such as Southern Co. (SO), based in Atlanta.
Today’s ultra-low interest rates have bond investors crying for yield. Opportunities are “thin and none,” said Scott Colbert, head of fixed income investments at Commerce Trust in Clayton, and manager of the Commerce Bond Fund.
Falling interest rates allowed multisector bond funds to return 4.27 percent so far this year, soundly thrashing stocks, but that return would be hard to repeat.
Colbert’s advice to bond investors: Sit tight, “because you just don’t know where interest rates are going.”
Terril likes some foreign closed-end bond funds, such as Aberdeen Asia Pacific Income (FAX), with yields of nearly 7 percent and Templeton Global Income Fund (GIM), yielding 6 percent.
Some local analysts believe certain technology and health care stocks look attractive. Keller likes Johnson & Johnson, the drug company beset recently by recalls and quality problems in its pill-making plants. Keller points to J&J’s sterling long-term reputation, and he thinks they’ll get those problems fixed. “You get a bargain when there’s a problem,” he says.
DunckerStreett’s Sullivan likes Stryker Corp. (SYK), a maker of hip and knee implants that’s “good with innovation.” He also likes Praxair (PX), the industrial gas firm whose St. Louis plant exploded near Lafayette Square in 2005. Industrial gas demand tends to grow faster than GDP, Sullivan notes.
