Oxstones Investment Club™by Sarah Morgan, Smart Money,
Is the stock market rally the beginning — or the beginning of the end? Plenty of mainstream brokerages have taken the tepid position that the streak will continue through at least the end of the year, most of them also say the big gains end there. But a growing number of contrarians say investors who remain on the sidelines or pull out now will miss these first spikes of growth — and a rally that could extend for the next several years.
Already, the Dow is up 13.9% since the beginning of September, and the fourth quarter is historically a seasonally strong one for stocks. Some investing professionals believe the rally will go on even longer. “You’re set up for a best of all possible worlds,” says Charles Lemonides, the chief investment officer at ValueWorks, a wealth-management firm with a value investing approach. A strong, multi-year rally is just beginning, he says, pointing to aggressive monetary policy, the beginnings of job growth and improvement in consumers’ balance sheets.
But the biggest indicator that stocks are set to rise may be all those investors fleeing stocks and piling into bonds. For the 25th straight month since October 2008, they put more money into bonds than stocks; for the week ending Oct. 27, equity funds lost $2.34 billion and bond funds gained $5.31 billion, according to the Investment Company Institute. And the equity aversion extends from individuals to professionals, says David Winters, manager of the Wintergreen Fund (WGRNX). “After the financial crisis, people basically decided all they really wanted to own was cash,” he says.
No one ever said it was easy to be greedy when others are fearful, but contrarians say there are opportunities in equities. The Wintergreen Fund has about 90% of its money in equities right now, Winters says. Less than 18 months ago, they were only 77% invested. Although finding underpriced diamonds in the rough is usually difficult for a value investor, quality stocks are cheap enough now that “the diamonds are right in front of you, sitting on the sidewalk,” says Charles Lemonides, the chief investment officer at ValueWorks. “Pick them up if you want.” The S&P 500 currently trades at about 14 times earnings, which is already low by historical standards, notes Doug McEldowney, a portfolio manager at Northern Trust (NTRS: 50.60, -0.60, -1.17%) . His fund’s value portfolio is cheaper yet, at 12.7 times earnings.
Lemonides says he believes the Dow could be pushing 14,000 by the end of 2011 — a 22% gain from its current level. Consensus views on the future — that growth will be slow and markets will be volatile — tend to assume the present conditions will continue, he says, but that means “You’re never going to predict change. And change happens.”
Here are four more signs that suggest stocks are headed higher:
The Fed wants them to
The Federal Reserve continues to signal its determination to stimulate the economy with expansionary monetary policy, most recently through further purchases of Treasury securities. “Monetary policy works,” Lemonides says. In his view, changes in Fed policy inflated and burst the credit bubble, and the central bank is likely to be just as powerful in driving growth now.
Balance sheets are strong
The Dow 30 have $500 billion in cash and short-term investments, while companies in the S&P 500 have more than $2 trillion, says Neil Hennessy, manager of the Hennessy Funds. “Companies are making a whole lot of cash,” he says, and many are in strong positions to grow stock prices when Washington provides more clarity about the business environment, he says. Meanwhile, expectations for S&P 500 earnings are $85 a share this year and $96 a share next year. Price-to-earnings ratios don’t need to increase at all for investors to gain 13% by next year, McEldowney says. If the S&P 500 were a private company, its strong balance sheet, prospects for earnings growth and dividend yield nearly equal to a 10-year Treasury would make it an obvious buy, he says.
Shipping, auto sales and hiring are getting stronger
All three are signs of underlying economic improvement. Most people don’t think about trains, says Winters, but intermodal traffic — freight that moves through multiple modes of transportation without being unloaded and reloaded — is a great indicator of international trade, and U.S. “intermodal” rail traffic was up 14% year-over-year in October, according to the Association of American Railroads. Auto sales picked up 30% this year — still below the pre-crisis rate, but improving. And although the economy may seem like it’s not adding jobs fast enough, that trend also is moving in the right direction, Lemonides says. Nonfarm payroll employment increased by 151,000 in October, according to the Bureau of Labor Statistics.
Bonds are bunk
Bond returns are so low that buying them only makes sense if investors expect deflation, says Kenton Russell, a portfolio manager for Sterne Agee. But commodity prices are rising, suggesting inflation is on the way (wheat prices are up 45% since June 30, cotton is up 60%, sugar is up 92%). Investors’ flight to safety is blinding them to the compelling opportunity stocks present in comparison to bonds, he says. “People have abandoned the search for opportunity because they’re too scared to look or have convinced themselves it no longer exists,” he says. “In that scenario, opportunity is cheap because demand for it is understated.”
Read more: 4 Signs the Rally’s Here to Stay – SmartMoney.com http://www.smartmoney.com/investing/stocks/four-signs-the-rallys-here-to-stay–1289342314219/#ixzz158LduLex
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