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Financial Industry Insights from Advisors Asset Management
On August 21, 2015
Pictures Could Be Worth a Thousand Words…or a Fortune
The recent rout in the world equity markets has caused many investors to question the health of the U.S. equity bull market. Some pundits are even calling the market top and warning investors to cash in their stocks and move to the sidelines. We disagree. We believe the current dip in equity markets provides an opportunity to commit additional funds to equities, rather than reduce exposure. We believe that the bottom of this dip is imminently near and investors should feel emboldened to overcome their fear and embrace the lower prices. The potential rewards can be huge.
There are a number of reasons that lead us to this conclusion. I have provided some supporting “pictures” that I hope will convince readers to stay the course and even add to equity holdings. The first picture is a 5-year chart of the S&P 500. Note the trend line that shows support where the markets currently are. Since the beginning of the bull market in 2009, dips in the market that touch the support line should have been bought. We don’t see why it should be any different this time.
Source: Bloomberg Data
Our next observation is that bull markets typically end with euphoria. We have no investor euphoria, rather we have investor fear. CNN published an investor sentiment “Fear and Greed” index that tracks a number of market signals to gauge the level of market skepticism. At this point, investors are as fearful as they were at the bottom of the market in 2009. The current reading of the CNN Fear and Greed Index is “Extreme Fear.” It has been at this level for over a month. Fear climaxes tend to mark bottoms of markets, not tops. Fear in the market as U.S. equity markets is also seen by the $8.3 billion of outflows, while money crowded into Government/Treasury funds. We think this fear should be embraced and money should be put to work in equities.
Source: CNN
Next, we look at the potential for earnings growth for the balance of 2015 and into 2016. We know that U.S. GDP continues to sluggishly grow and employment numbers continue to post strong results. Our Fed continues to remind us that they desire to end the “Zero Interest Rate Policy” with a gradual and measured rate hike this year. Our more favored and we believe more accurate gauge is the slope of the U.S. Treasury yield curve. The yield curve is made by plotting the yields on U.S. Treasury securities from short maturities to long. Historically, if the curve is positively sloped it tends to be coincident with economic growth. A flat or inverted curve tends to indicate a slowing of economic growth or even a recession. The current shape of the curve, as measured by the 30-year Treasury bond minus the 5-year Treasury note, is still very positive. This tells us that the outlook for growth in the U.S. economy is continuing. The chart below, provided by Bloomberg Data, shows the steepness of the curve over the past few months.
Finally, our last observation that supports our thesis is that liquidity is still very plentiful for the U.S. economy and low commodity prices are very stimulative. We note that the Fed, even in their desire to end crises-era monetary policy, is very accommodative. Further, the collapse in commodity and energy prices makes it easier for the users of those materials to make money. Lower input prices should help them raise profit margins. This has been tempered somewhat by a stronger US dollar, but still most companies could be net winners.
We like the United States, but we think there are superior opportunities in Europe and Asia as they benefit from weakening currencies, full blown quantitative easing, as well as lower energy and commodity input prices. Most central banks around the world are easing monetary policy and targeting inflation creation. They have unlimited tools and will likely achieve their goals. This would bode well for exposure to emerging markets which would benefit from a bit of inflation. We are currently at a trough in the energy and commodity cycles which would likely change as demand begins to increase.
All in all, we think this dip in the world equity markets should be bought. We find none of the “classic” signs of a market top; rather, we find the conditions that surround an interim bottom. We think the Warren Buffet quote, “It is good to be greedy when markets are scared and scared when markets are greedy” is apropos here. We think that right now, greedy is good!
CRN: 2015-0805-4891R
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