Stocks are overreacting to the unfortunate confluence of events: the downgrade of U.S. government bonds, some weaker than expected economic data, and the troublesome but manageable U.S. fiscal position. Along with sovereign debt issues threatening Europe, these factors turned market sentiment ugly.
Former Federal Reserve Board Chairman Alan Greenspan put it this way last Sunday on Meet The Press: “The United States can pay any debt it has because we can always print money to do that. So there is zero probability of default.” Greenspan, who is not an oracle but who does have years of experience in running the nation’s central bank, added that the downgrade “hit the self-esteem of the United States, the psyche.”
While such a blow to our nation’s financial reputation cannot be dismissed and must be addressed, it’s also important to remember that there has been no real change in fundamentals driving the economy.
Improving economic data is plentiful. “The leading indicators point to slowly expanding economic activity in the coming months, according to the Conference Board’s most recent appraisal of the economy.
Weekly unemployment claims have tumbled from the April 2009 peak. The Bureau of Labor Statistics reported modest improvement in job growth for July. Layoffs of government workers have masked a jobs rebound in the private sector that looks fairly typical at this stage of an economic recovery. Economists cite renewed July-August auto hiring and a slower pace of state and local government layoffs ahead as reasons for optimism on initial claims for unemployment benefits.
Corporate earnings estimates keep climbing. Q2 nominal Gross Domestic Product is up 3.7%, while Q2 revenues on Standard & Poor’s 500-companies were up a whopping 13.2%!
Earnings estimates for 2011 and 2012 rose again last week, continuing a trend of upward estimate revisions.
The S&P 500 is trading at 11 times 2011 earnings estimates. Investors right now can choose to buy the 10-year Treasury bond with a 2.3% yield or get a 2.2% dividend yield on the S&P 500 plus the potential upside on stocks. Will the relative value of stocks versus the 10-year Treasury Bond ultimately be recognized by investors? History may not repeat itself. It’s possible. But using historical valuations and economic fundamentals to guide long-term investment decisions is prudent.
Hysteria is not new to investment markets. While it not easy to ignore the gyrations, our advice is to resist the panic by staying focused on fundamental factors that drive long-term values in securities markets.
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