It's the Economy, Stupid
Advisors Capital Management
Charles Lieberman
September 7, 2010
Stocks are so totally out of favor, any excuse will suffice to justify investing elsewhere. Such rationalizations can overcome depressed equity valuations and record low bond yields, at least until the market rallies and investors suddenly confront that new reality. But the key is the economy. If growth is sustained, stocks have enormous upside.
The consensus estimates for 2011 earnings is about $91, implying a projected price earnings multiple of around 12.5 or an earnings yield of almost 8%. These metrics compare to a yield below 2.75% on 10-year Treasuries. Equity valuations are so compelling when compared to bonds that we must conclude that investors dont believe that companies will reach the earnings projection. Implicitly, investors are betting that the recovery will not be sustained. These doubts are shared by stock analysts, who lack conviction in their own earnings estimates. Despite the solid earnings estimates, only 29% of stock recommendations are rated "Buy" and a record 66% are rated "Hold".
Investors and analysts share the concern that the economic expansion will falter, making the 2011 earnings estimates unreachable. But while the fear of a "double dip" recession is understandable, the economic conditions that would cause a decline in activity are lacking. Inventories are under control, companies are sitting on record amounts of cash, financial market conditions are extremely accommodative, the banking system has been recapitalized, billions has been raised to purchase "distressed" commercial properties, housing construction is extremely depressed and less than half of the rate of household formation, and car sales are still below the rate at which cars are being junked. The economy is producing private sector jobs, even if the rate of job formation is unsatisfactory. It is hard to see how economic weakness would set in under these conditions. More likely, growth should pick up at some point.
Stocks are not priced for any good news at all. Investors fear the worst. If growth picks up at all, stocks should perform very well, while "safe" bonds get hammered. Even an unimpressive payroll employment report on Friday was sufficient to set off a strong equity rally. What happens if growth becomes a bit stronger? The market is simply not positioned for that possibility.
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Advisors Capital Management, LLC (ACM) is a provider of privately managed portfolios and financial planning services for industry professionals and direct clients. Although the information included in this report has been obtained from sources ACM believes to be reliable, we do not guarantee its accuracy. All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. ACM is a registered investment advisory firm. For program fees and descriptions please request a copy of the firm’s ADV part II Schedule F. Web Address: www.advisorscenter.com 777 Terrace Ave, Hasbrouck Heights, NJ 07604 Phone: 201-426-0081
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