Stocks are cheap and they need to get more expensive. They're cheap relative to bonds and cash, and even absolute in themselves are shrinking because earnings are growing faster than prices (See our past commentary, "Multiple Expansion"). And we're heading toward the 14th consecutive quarter of double-digit growth for the S&P 500 to boot. (See our past commentary: "Consistently too Low, Again").
For stocks to be this cheap for this long is a pretty rare thing and investors are starting to pick up on it. To wit:
Mutual Funds and the Buyout Boom
By Diya Gullapalli, The Wall Street Journal
It's only rational for fund managers and investors in general to recognize the fundamental and bullish underpinnings for big stock buybacks and booming M&A activity. This trend is set to accelerate based on fundamentals alone. For more on just what those fundamentals are, we've spilled a good deal of digital ink on the topic with these commentaries:
- The Age of Conglomerates
- Privatizing Profits
- Not All Destruction is Created Equal
- Even More Destruction
Now that investors are starting to get a handle on this notion, that means demand for undervalued equities and prime takeover candidates should rise in kind. That also means, despite the calls of many economists and analysts, small caps and value stocks should continue to perform very well (both of which are more likely to be acquired than big and growth stocks).
The bottom line is that stocks are worth more than their current prices, and one way or another the market will get itself to the appropriate equilibrium. CEOs are only just now beginning to shun their risk aversion from the last bear market. Many companies are flush with cash and haven't truly loosened the purse strings enough in terms of buying back stock and making acquisitions—activities that automatically raise earnings because the cost of capital to is simply cheaper than the value of the assets being purchased. It's just that simple.
So if the CEOs won't move quick enough, the markets will. Investors are finding the attractive takeover candidates and the most deeply discounted stocks and buying them—raising share prices in anticipation of their holdings either being acquired, or simply because there are many very attractive undervalued companies out there. Either way, it's a good thing for investors—whether a holding goes up because it gets bought at a premium or it simply enjoys strong price appreciation is irrelevant.
We suggest the CEOs seize the opportunity at hand and get share prices up with strategically sound cash acquisitions and stock buybacks. If they don't, the markets will do it for them.