Good News or Cheap Stock Prices, but Not Both
Advisors Capital Management
By Charles Lieberman
January 16, 2012
Investors often fail to appreciate that they can have either good news or cheap stock prices, but not both. It is good news that provides confidence and elevates stock prices to high valuations. Bad news undermines confidence and depresses stock prices. This maxim, first expressed by Joe Rosenberg, Chief Investment Officer for Loews Corp., and repeated in Barron’s, applies most appropriately to prevailing stock valuations and implies an exceptional buying opportunity for those who can take a longer term investment perspective.
Stock valuations are depressed no matter what reasonable valuation methodology is used. The S&P 500 is currently trading at a 2012 price earnings multiple of 12.6, compared to an average of about 17 times since World War II. But, price earnings multiples normally (and theoretically) vary inversely with inflation and interest rates. For example, price earnings multiples were well below 10 during the high inflation, high interest rate 1970s and above 20 during the low inflation, low interest rate 1950s. So, today’s below average price earnings multiple is highly inappropriate and implies that stock prices are extraordinarily cheap.
Why are stocks so cheap? Sure, there are many concerns. Europe must rein in sovereign budget deficits and Greece might default. Iran threatens the U.S., seemingly almost daily. The Middle East is in political turmoil. Nuclear-armed North Korea, belligerent under the best of circumstances, has a new untested leader. Domestic economic growth is still sluggish and unemployment remains high. And domestic policy remains uncertain, especially in an election year. But it is easy to overplay these concerns. Are they materially worse than when the Soviet Union, with its vast nuclear arsenal vied with the U.S. for global clout? Domestic shale may greatly reduce U.S. energy dependence on unstable parts of the world. Fed policy is very much oriented towards a stronger expansion. And in an election year, the rhetoric is bound to embellish our real problems. Just as conditions are never as good as they appear when all appears well, they are never as bad as appears to be the case when we have significant concerns. Prevailing fears have wrung all excesses out of the market. If there’s a bubble anywhere, it has pushed Treasury bond yields to unsustainably low levels and stocks are correspondingly cheap.
The above is not to suggest there are no legitimate concerns. We can easily identify significant risks that must be monitored and protected against. But it also suggests that sentiment is unduly negative, which creates a great buying opportunity.
(c) Advisors Capital Management
