- While it's undeniable there are real problems today, this bull market correction is based on overwrought fears of those problems instead of reality.
- Fears can hold markets back short-term, but fundamentals win out over time.
- As investors focus evermore on the slowing US economy, the global economy continues to be prosperous.
Today's bull market correction is predominantly based on overwrought fear. Fears can hold markets back in the short-term, but fundamentals inevitably, inexorably win over time. While there are real problems today in certain sectors such as housing and Financials, global economic and market fundamentals are better than most believe. In the midst of today's turmoil, it's worth taking a step back and recognizing a few of the positives in the bigger picture.
Long-term interest rates remain low and inflation is not rampant—globally
Access to capital is necessary for companies to grow. Liquidity remains plentiful for healthy borrowers. Further, many with good credit can actually borrow at rates lower than they could a year ago. Look for larger companies to thrive in this environment (they tend to have the better credit ratings) as smaller companies with lesser credit ratings struggle.
Also, the 10-year Treasury yield at roughly 3.5% is the market's way of saying inflation is not a long-term concern. Think back to the ‘70s—a time with true inflationary pressures. Government bond yields bounced around from 7% to just over 10% by the end of the decade. It's true today inflation has ticked slightly above the Fed's "comfort level" of a couple percent, but these are far from runaway levels.
Euphoric investor sentiment is nowhere to be found—globally
We all can probably agree on this one: There's a lot of anxiety out there today. Believe it or not, pessimistic masses are bullish. The consensus is notoriously poor at predicting recessions and bear markets—this time is no different. Remember an oldie, but a goodie: "Bull markets climb a wall of worry." For a true bear market to materialize it needs widespread denial of negative fundamentals (i.e. tech bubble of 2000). Today is precisely the opposite—ultra-dour sentiment with a complete disregard for the positives.
Stocks remain cheap and stock supply growth is restrained—globally
As evidenced by current earnings yield/bond yield spreads, large cap stocks continue to look cheap when compared to investment grade bonds, Treasury bonds, and cash alternatives. While not a timing tool, the earnings yield/bond yield spread bodes well for stocks looking forward. Furthermore, large companies are taking advantage of cash-flush balance sheets and ample access to liquidity by continuing to engage in M&A and share buybacks. While indeed there have been a spate of Financials share issuances of late (including the Visa IPO) and some stock-for-stock mergers, there have also been continued cash-based mergers and buybacks such as IBM's recently announced massive share repurchase. On balance, new stock supply has remained restrained so far this year.
The fourth year of a US president's term and political inactivity abounds—globally
Stock markets hate political changes, which typically cause dislocation and inefficiency. Markets prefer the status quo. The third and fourth years of a president's term are generally legislatively feckless. When it comes to politics, we like feckless. While election buzz will no doubt get louder in the coming months, don't expect that to translate into new legislation. While it's not impossible a potentially harmful piece of legislation could squeak by given today's economic fears, it is not a likelihood at this time. (For more, see our cover story from 3/4/08, "Pick Your Poison.")
Internationally, the geopolitical landscape looks equally benign. There's a new Australian Prime Minister—he's been silent so far. There's also been quite a bit of gabbing from Sarkozy (France) and Merkel (Germany), but all in all nothing terribly impactful. Recent elections in Central and Eastern Asian countries were high profile, but ultimately became relative non-events as well.
Most importantly, it's a global economy—more so now than ever before
Perhaps the least discussed aspect of the current environment is the disproportionate focus on the US. Of course, if you live in America, you'll tend to focus on the US economy and its effect on you (i.e. housing, gas prices, unemployment). Fair enough. However, it's nothing short of financial recklessness for investors to ignore the globe. Some folks may find it surprising the IMF's most recent figures show the US, while the largest economy, accounts for only about a quarter of the global economy. (For more, see our cover story from 2/14/08, "America's Love Affair.")
And the global economy is far more integrated than ever before. The IMF projects the global economy is set for another year of fine growth (see our cover story from 1/30/08, "Still Growing"). The US is expected to grow in 2008. Will it be the rocket-blasting growth we've seen in recent years? Maybe not, but it's nowhere near today's Apocalyptic talk either. We should note amid all the hoopla and declarations of the US already being in recession, there has yet to be a single quarter of negative GDP growth. That said, it's not impossible that the first quarter's '08 US GDP growth will come in negative versus a year ago. But whether one quarter's reading is slightly negative or slightly positive is not the point. It's vastly more important at this juncture to recognize this is not the territory of an economic meltdown for 2008.
To this day many view non-US stocks as risky. The opposite is true. Reviewing the current bull market, it's clear a global mindset is of great benefit. Yes, there will be times when the US markets outperform foreign markets, just as foreign markets have outperformed the US during this bull. However, we doubt it will ever be prudent to completely ignore either the US or foreign countries regardless of who outperforms—world economies are too connected.
The broader, positive economic and market landscape of today's world is being positively ignored. That won't last forever, and we suggest investors see today as an opportunity rather than Armageddon.