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After 2018 loss, stocks no longer look overvalued

07 January 2019

(St. Louis Post Dispatch)

January 6, 2019 (David Nicklaus)

Last year, for the first time in a decade, stock-market investors found themselves counting losses instead of gains.

It was a rough year that included two corrections of 10 percent or more, and came close in December to meeting the bear-market definition of a 20 percent loss, but the overall carnage was not nearly so historic.

When you include dividends, the Standard & Poor’s 500 had a total return of negative 4.4 percent last year.

While no one likes to lose money, investors have to expect a bad year once in a while. The S&P 500 has posted negative returns in 11 of the past 50 years, and the average loss in the down years has been 14 percent.

Against that backdrop, 2018 doesn’t look so bad – unless you got caught up in the cockeyed optimism that prevailed a year ago. Tax cuts were boosting both corporate profits and investor enthusiasm, and the world’s major economies all seemed healthy.

Now the tax cuts are in the rearview mirror, President Donald Trump has started a trade war and growth seems to be slowing in the U.S., China and Europe.

The stock market’s 19.8 percent tumble between Sept. 20 and Christmas Eve reflected that kind of pessimism. “The conventional wisdom has gone from nonchalant optimism to, ‘Oh, my gosh, here we go again,’” says Norman Conley, CEO and chief investment officer at JAG Capital Management.

Conley watches various indicators of investor sentiment, from surveys to technical data such as the ratio between put and call options. All have gone from modestly positive in September to significantly negative now. “It’s amazing how the narrative shifts in a short period,” he said, “but this is just good old-fashioned human emotion, and it overshoots in both directions.”

Based on valuations, Ken Crawford figures it’s a pretty good time to own stocks. Someone who buys the S&P 500 is paying about $14 for each dollar the component companies are expected to earn in 2019, well below the $18 they were paying a year ago.

“That’s a pretty cheap market,” says Crawford, senior portfolio manager at Argent Capital Management. “I like stocks here if we’re not going into recession.”

The R-word is, of course, the big worry. A recession could be triggered if the Federal Reserve raises interest rates too fast, if Trump imposes even steeper tariffs or if the government shutdown continues long enough to erode confidence in U.S. institutions.

All those things could happen, but we could also see the shutdown end, the Fed put rate increases on hold and the U.S. and China negotiate a trade truce. Some upbeat news might reverse sentiment and send investors hunting for bargains in beaten-down sectors such as banking and semiconductors.

Joe Terril, president of Terril and Co., thinks the market underestimates the likelihood of such a positive outcome. “My best guess is our administration isn’t so blockheaded that they are going to let the world economy grind to a halt,” he said.

Joe Williams, director of investment strategy at Commerce Trust, also thinks stock-market bears will retreat in the year ahead. “We’re in the process of making a bottom,” he said. “I think stocks look very attractive here.”

Even if the bears keep growling for a while longer, investors must realize that occasional rough patches are the price one pays to enjoy the market’s long-term returns. Having just paid that toll for the first time in a decade, now’s not the time to turn tail and run.