It is a good time to be a U.S. stock investor for the long term – if you can ignore the noise erupting every few hours.
That is the advice from some money managers, who are taking the opposite tack of many who want to avoid the turbulence. Instead, they are confronting the volatility head on, adding to stock allocations rather than standing pat.
Much of their increased optimism stems from a belief the U.S. economy is likely to avoid another recession, even as a European downturn seems more likely.
Because of that, they believe the euro zone’s debt crisis, which has kept the market on its toes for months, will recede as the main driver of market direction. A Reuters poll of 12 U.S. fund companies showed managers in December boosted equity holdings to their greatest percentage this year.
But for those worried investors who have been out of the market for a while, Shawn Kravetz, president of investment management firm Esplanade Capital, suggests starting small.
“You should start to deploy capital into the stock market gradually and, in the coming months if it’s up, you keep doing it. If it’s down, you get a little bit more aggressive,” said Kravetz, who favours large retailers, including Lowe’s, Target and Wal-Mart.
U.S. economic data has improved in recent months. That is likely to help U.S. companies continue to report healthy profits, among the biggest tailwinds for stocks in 2012.
But there remain many reasons to be wary. Even optimistic money managers acknowledge that Europe’s debt troubles are far from over and the fallout could still extend to the United States, especially the U.S. financial system.
Cautious retail investors overall still prefer bonds and cash to stocks. Assets under management at all equity funds dropped by $186-billion for the year through December 12, according to Thomson Reuters’ Lipper. For the same period, assets under management at all taxable bond funds rose by $69.8-billion.
The well-worn arguments about attractive valuation have not won the day in 2011. The benchmark Standard & Poor’s 500 appears headed for another losing year, despite valuations that have not been this low in a decade.
The index is down 4.2 per cent for the year, and stocks have been on a topsy-turvy path for months, showing strong gains one day, only to slump the next.
By contrast, investors in the Barclays U.S. Treasury Aggregate Bond index are sitting on returns of nearly 10 per cent for 2011, according to Barclays Capital. That’s despite a bevy of predictions that the bond market had nowhere to go but down this year.
STOCKS GO THEIR OWN WAY
Major asset classes have traded in tandem with one another for the last several months. The euro, commodities, stocks and sovereign credit markets have been increasingly linked because of fears of a financial meltdown in Europe.
The tight relationship between stocks and the euro has diminished in the last month, however. In October, the euro and the S&P 500 nearly matched each other in the direction and magnitude of their moves. The rolling 22-day correlation coefficient, which represents how close a relationship the two assets have, was last at 0.14.
A perfect relationship is 1, with 0 making two assets essentially unrelated. In late October, the correlation was routinely above 0.9.
High trading correlations between stocks in the same sector have resulted in many “mispriced” stocks, said Craig Hodges, president at Hodges Capital Management in Dallas, Texas.
“Equities move in lockstep day in and day out, irregardless of individual fundamentals. What you have are situations where babies are thrown out with the bath water,” said Ken Farsalas, who manages a small-cap growth fund at Oberweis Asset Management in Lisle, Illinois.
The price-to-earnings ratio of the S&P 500, a measure of the price paid for a share relative to the company’s profit, is low by historic standards. The S&P 500’s forward P/E ratio of 11.3 is at its lowest in more than a decade, S&P data shows.
One approach to investing in stocks today is to aim for global diversification, according to Todd Petzel, chief investment officer at Offit Capital Advisors.
“If you focus on global franchises with good cash flows, the stocks still are trading at very reasonable multiples and have very good prospects,” he said.
Petzel also noted mortgage real estate investment trusts, or REITs, are good bets for retirement accounts, because of the steady stream of cash and low valuations. “We think the cash flow is very good and steady and they’re trading at very near book value these days.”
Annaly Capital Management and MFA Financial are in his retirement plan and many of his firm’s clients’ plans.
Valuation has proved a tough sell in the last several months. Banks, which trade at less than the value of the assets on their books, were hit again on Monday.
Calm periods in markets have been brief this year. Markets do not often repeat the stomach-churning periods that marked August through October, but Tobias Levkovich, chief equity strategist at Citigroup Global Markets, says recent declines in volatility may still prove transitory.
Many see the market’s choppiness as here to stay, and suggest investors accept it.
“It’s painful, it’s hard, but sometimes it’s better to turn off (the news) and take a step back,” Farsalas said.