INSIGHTS

On May 07, 2012

The Current Market: Short-Term Discounts Could Equal Long-Term Gains

As we embark on the anticipated “sell in May and go away” mantra, it might be of interest to look at where some of the value metrics lie currently. We see many of the same concerns that prompted the sell-offs the last couple of years at roughly this time; least of which is the percolating European issues and the price of gasoline. The more important components, in our eyes, are the events surrounding China with regard to its “stagnant” GDP running at a little above 8%, the November U.S. political transition and the intriguing diplomatic events that occurred recently.

If you recall from our Strategic Times: Year in Review & Looking Ahead piece, the following metrics may surprise you with the run up in the equity markets, specifically the S&P 500.

Source: Bloomberg 

On a broad-based level, there appears to be significant value at current levels. However, consider some of the subsets inside the S&P 500:

• Standard and Poor’s Info Technology is trading at 14.7 times while the average multiple of this index over the last 10 years has been 22.4 times, or a current discount level of nearly 35%. As a little incentive, consider earnings expectations are expected to grow 15.17% by years end from current levels.
• The S&P 500 Financial components are trading at 1.02 multiple of price-to-book value while average over last 10 years has been around 1.40 times.
• The S&P 500 Healthcare component is trading at 12.9 times earnings currently with a price-to-cash flow of 10.20 times. Both of these are discounts to averages of nearly 20%. One may find an interesting seasonal pattern in the Healthcare component of this index that has sold off 16% during the summer months over the last two years. We don’t foresee as significant a selloff in this sector this year, but if it were to occur, it may prove beneficial to buy this sector on the dips.

Today, we also received via the media that Warren Buffett is continuing to buy stocks due to their value. According to an MSNBC interview, Mr. Buffett stated, “Well it really doesn’t make any difference to us. We were buying stocks on Friday and we’ll buy the same stocks today and we’ll buy them a little cheaper. I never complain about buying things cheaper.”

Though we would agree with this sentiment, the market could rally from the current level and a discounted value would still remain. If the sell in May crowd does become the majority, the minority of buyers look to benefit from our perspective.

To further illustrate this opportunity over the long run, consider the rolling 10-year S&P 500 returns since 1926 that we brought out in December.

Reversion to the mean may prove very profitable to those investors willing to buy when sellers abound and hold while the buyers push equity prices back to the mean. Though it may not have proven successful in the last decade, positions and patience may be the two ingredients to successful investing in the next decade.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at www.aamlive.com/blog/about/disclosures. For additional commentary or financial resources, please visit www.aamlive.com