It’s summertime and the mercury has being rising, setting one record after another across much of the country. As usual, traders and investors have headed off to the Hamptons or some other fair destination. Daily trading volume, already thin, has slowed even more. In Europe the story is the same, with the streets of Paris and other major cities nearly empty, save for the few tourists from abroad. With so many away from their desks, it’s difficult to make much of what’s going on in the equities markets these days.
Stocks in the U.S. are down less than 5 percent from their recent high, after touching their highest level in more than four years. Yet investors remain quite nervous. To be sure, the economic data of late has been soft. Take Friday’s employment situation report, for instance. Just 80,000 jobs were created last month. Given the number of people entering the work force, that’s not enough to keep the unemployment rate steady, much less cause for it to decline. Meanwhile, the second-quarter earnings season kicks off today. And year-over-year profit gains are poised to fall into the single digits after displaying strong gains coming out of the Great Recession. Uncertainty surrounding Europe means companies will likely also offer cautious outlooks and be reluctant to boost their spending plans for the time being.
Across the Atlantic, much of the euro zone has slipped into recession. And while policymakers there are inching toward a unified banking system, the steps they’ve taken so far have not been enough to lower borrowing costs for the weaker countries for more than a few days at a stretch. Moreover, the push for austerity could keep growth at bay for some time to come unless concrete measures are taken to foster growth.
Moving our focus to the 900-pound gorilla of the developing world, China, we see a welter of news stories filled with gloom and doom: predictions of a “hard landing,” weaknesses in the real estate sector, serious problems with infrastructure and more – all of which would certainly have grim implications for the rest of the global economy. True, China’s economy has cooled down from the blistering 10-11 percent pace we witnessed in recent years. But its current growth rate in the 7-8 percent range is still robust, especially in comparison to the economies of Europe and the US. Plus, China should benefit from several interest rate cuts of late, and the Chinese central bank has ample room to cut rates even further if necessary, while incentives to get Chinese consumers (who are notorious savers) to open their wallets should also pay off.
Interestingly, in contrast to the “hard landing” scenario so many ascribe to, New York-based research outfit CBB International reports that economic activity in China is actually picking up, although this is not yet reflected in official government statistics. This view dovetails with our own assessment of the country. CBB conducted a survey modeled on the Federal Reserve’s widely watched Beige Book, and the results found improvements in China’s retail, manufacturing and property sales, along with continuing shortages of unskilled labor. All of these are encouraging signs that the country’s economy is far from grinding to a halt. Again, official government statistics probably lag CBB’s data by several months, so we would expect to see more bullish data from Beijing in August and September and into the fall.
Getting back to our own territory: The nervousness that American investors are displaying, reflected in tepid readings in various sentiment surveys, is in stark contrast to the complacency typically seen when markets are on the verge of a big decline. Valuations, meanwhile, are quite reasonable in terms of earnings, cash flow and sales. This suggests that much, if not all, of the bad news out there is currently reflected in share prices. And that leaves plenty of room for upside surprises.
The bottom line: While stocks will bounce around from day to day depending on the headlines, we don’t expect much in the way of either a decline or an advance in the next couple of months. Expectations for more quantitative easing should help to keep a floor under share prices, while headline jitters and slow growth worldwide will cap any upside advance.
Given this backdrop, it makes sense to focus on fundamentals. Consider the stocks that make up the Growth Portfolio in our flagship publication, The Complete Investor. As a group, we expect profits for our stocks to climb twice as fast on average as the S&P 500 this year. At the same time, our stocks are selling for much less than the market as a whole, despite their much better growth prospects, with PEGs (price/earnings to growth ratios) at roughly half of the S&P 500 average.
Investors with stocks like these can head off on their own vacations, confident in the knowledge that their holdings are much safer than the market as a whole, and likely to continue to grow at a healthy pace even if the economy continues to merely lumber along.
