In March 2009, as the outlook for the world economy and financial system offered investors little optimism, I wrote an article that discussed the rare occurrence of the magnitude and duration of the decline in stock prices – an event that happened only three times in the last 110 years!
At that time, the stock market hit a significant bottom, and broad equity averages are 60 percent higher today as the U.S. economy pulled out of recession five months later, during the third quarter of 2009.
Since the fall of 2009, the cross-currents of recovery and the vestiges of the credit crisis have created a tug-of-war for investors. There have been two significant rallies and two significant corrections of the magnitude of 10 to 15 percent each. Employment trends have only improved modestly, and stock prices are at similar levels today as they were in the fall of 2009.
World economic events caused consumers, businesses and investors to reduce debt levels, increase cash and maintain a conservative posture during these unsettling events. The European debt crisis highlighted the concerns of governmental deficits and the slate of unattractive consequences to restore fiscal discipline. Recently, markets have reflected the prospect of falling back into recession (double-dip) and the prospect of larger government via more regulation and higher taxes.
While these concerns are real and stock prices have flat-lined within a volatile range over the last nine months, we believe there is still plenty of opportunity for investors.
Stock prices haven’t appreciated significantly over the last 9 months. However, corporate profit margins, net income and balance sheets have improved dramatically. Cash held on corporate balance sheets is at 40-year highs and net income is up over 20 percent. With stocks at similar levels as they were nine months ago, a share of stock in general is more than 20 percent cheaper for the current level of earnings.
This is a simplistic way of saying there are earnings and cash value available in stock prices today.
When will this valuation opportunity be realized? We believe it will take time for employment trends to improve, deficits to be addressed, and sustainable economic growth to be realized. Elevated stock price volatility will be with us for the foreseeable future as tough decisions need to be made, but the underlying potential of our economy and the improving financial condition of consumers and corporations will be a catalyst for sustainable stock appreciation in the years to come.
