16 augustus 2011
By John Carey, CFA

Since peaking for the year at 1371, the stockmarket, as measured by the Standard and Poor’s 500 Stock Index (S&P 500), fell 12% to 1200 at Thursday’s (4 August) close. Last year, by comparison, the market suffered a 17% correction between 26 April and 1 July.

Having experienced many market setbacks over the years, I never find them easy – and I’m quite sure that you don’t, either. But I’ve learned that all market declines have a few things in common:

1. Each of them feels like “the big one”.

2. Each is explained by circumstances that people feel cannot change and that will only produce further decline.

3. No one can think of reasons to buy, and so the bargains just sit there.

4. Historically, market declines have run their course and ended, just like the breaking of storms.

Here are the things that appear to be worrying people right now:

1. European countries are experiencing serious financial difficulty.

2. The US economic environment is faltering and the politicians in Washington have just presented a debt ceiling agreement that many commentators find puzzling and unsatisfactory.

3. More fundamentally, investors are starting to worry about corporate earnings and a slower economy. Much of the earnings growth we’ve had over the past two years has come from cost cutting, favourable foreign currency and inventory rebuilding, which have all about run their course. We were just starting to get the required sales growth to propel earnings to the next level. The weak economic numbers now throw that into doubt.

4. In looking at demographics and recalling the large numbers of people retired or soon to be retired, investors think that risk appetite will be very limited. The sharp volatility of the market will only, they feel, further disincline older people from taking risk. Considering, then, that prices of securities result from supply and demand, investors increasingly favour securities of lower risk, which they believe will be in greater demand. That has implications for longer-term demand for stocks, particularly those of higher risk.

Here is what I can offer by way of encouragement:

1. Equity valuations after this correction have become even more compelling than they were, with the S&P now at barely 13 times earnings (as at 4 August).

2. Dividends continue to go up and provide yields that are very competitive with those of other income-producing investments.

3. Corporate mergers and acquisitions are proceeding.

4. Share repurchases have been accelerating. 5. Many US companies today derive large parts of their earnings from overseas, where economic growth remains stronger.

6. Finally, the market does indeed fluctuate, but over longer periods it has trended upward. Past performance cannot, of course, guarantee future results. There can be no assurance that this time it will not be different. However, we prefer to be optimistic.

In the meantime, there appear right now to be a lot of bargains on offer in the market after these sudden summer mark-downs and I suggest investors might want to have a look at them and talk to their advisors about doing the same.

In Conclusion

I can’t tell you what the catalyst for a new market advance may be, but I do believe that at these levels, the market is potentially quite attractive. Those who can tune out the negativity, look at the prices and think about opportunity may be pleasantly surprised by the potential values in the marketplace today.