Large Cap Commentary – September 2012
Last month I wrote of the improvement within the United States housing market. The Fed’s latest initiative, QE3, or Open-Ended Quantitative Easing (QEOE) should further help the housing market by keeping interest rates low for an extended period of time. This push by the Fed, unfortunately, is indicative of the tepid U.S. economy. However, it is important to note that outside of the U.S., economic trends are even worse. Today, much of Europe is in a recession and growth rate estimates for China are being lowered on a weekly basis. Overall, there is and has been a great deal of uncertainty in the world – generally not a positive backdrop for equity investors.
All that being said, those who followed the adage, “Sell in May, Go Away”, left a good deal of money on the table. The S&P 500® Index is up over 16% on a year-to-date basis, and rose by 6% in the third quarter alone. To many, this seems contradictory. Why would the stock market be so at odds with the wall of worry that has surrounded investors for 2012?
The best explanation is valuation. Recall that only a few months ago the market was trading at a 12x price/earnings multiple. In other words, investors were paying $12 for each $1 of earnings within twelve months. A more ordinary value for the market is 15x price/earnings. At face value, this implies that the market was very inexpensive; likely reflecting some of the aforementioned concerns. Uncertain times cause investors to consider alternative investments to stocks. The largest alternative to stocks is bonds. As we have mentioned several times over the course of this year, bond yields are currently very low and they will likely stay low given the Fed’s most recent actions. Investors, as a result, have decided this year to take a little more risk and the stock market has been the beneficiary.
Finally, although the growth rate of the U.S. economy is low, it is positive. In addition, U.S. corporate balance sheets are quite strong. Simply put, companies are sitting on a lot of cash. This scenario leaves investors choosing between low bond yields or low priced stocks, where fundamentals have been improving. Not surprisingly, investors voted with their dollars and the stock market rose nicely during the third quarter. Today, the price/earnings of the S&P 500 has risen closer to a 14x price/earnings multiple. At these levels stock still appear favorably valued, but less so than a few months back.
It is upon this backdrop that we enter the fourth quarter. While perhaps some of the market’s easy money has already been made, we at Argent will continue to focus on finding those companies successfully executing on their business plans while maintaining a reasonable valuation. There are still many companies from which to pick.
As always, we appreciate your interest in Argent Capital Management.
Senior Portfolio Manager
Views expressed herein represent the opinion of the portfolio manager as of the date above and are subject to change.