Six Reasons to Be Optimistic

09/04/2014 9:00 am EST

Focus: STOCKS

John Buckingham

Editor, The Prudent Speculator

We never lose sight of the admonitions of Peter Lynch who said, "The key to making money in stocks is not to get scared out of them," asserts John Buckingham, editor of The Prudent Speculator.

No doubt, the 2014 additions to the Wall of Worry—the slowdown in economic growth in China, the continued near-recession in Europe, the drama in Ukraine/Russia, the contraction in Q1 US GDP, debt issues in Argentina, hostilities in Iraq/Gaza and the Ebola scare—have provided plenty of fodder for the Doom and Gloom crowd to convince fearful money to stay sidelined.

But we remain optimistic on the balance of 2014 and beyond. We are not cavalier in our lack of grand concern for these events as we know that short-sighted traders can send stocks sharply lower very quickly.

However, we think it is far better to stay on course with one's long-term investment objectives than to try to time the gyrations of an often-schizophrenic market.
 
Though we still have more than two months to go in the seasonally less favorable time of the year (May-October), including the statistically worst month of September, we think that those who share our long-term time horizon should be optimistic about the US equity markets. Our rationale includes:
 
1. Valuations are reasonable for the stocks in our portfolios, especially given the interest rate backdrop

The trailing-12-month P/E ratio of 16 on Buckingham Portfolio is more than three full points below that of our benchmark Russell 3000 index, while the dividend yield of 2.5% is well above that of the R3K.

Meanwhile, interest rates are still microscopic. It’s hard to get excited about a 1.6% 5-year US Treasury yield, while we note that, at previous equity market highs in 2000 and 2007, the yield on the 5-year was 6.5% and 4.4%, respectively.

Of course, historically, inflation has been in the 3% per annum range, so there is a very good chance that those who are hiding out in the perceived safety of Treasuries may actually end up losing purchasing power upon maturity of their 5-, 7- and even 10-year bonds.
 
2. Corporate profits are expected to show solid growth this year and next

Standard & Poor's presently estimates that "Bottom-Up Operating EPS" are expected to jump from $107.30 in 2013 to $119.27 in 2014 to $136.55 in 2015. Those numbers equate to EPS growth (according to S&P) of 11% this year and 14% in 2015.

3. Dividend payouts are on the rise while payout ratios are low

More than 40% of the companies that we own across our portfolios have already boosted their dividends so far in 2014, while balance sheets across Corporate America are generally in terrific shape.

4. The U.S. and global economies are muddling along

Despite awful domestic numbers in Q1, economic stats improved considerably in Q2 (and since the end of Q2), with the rest of the year likely to see a continuation of that trend. 

5. The Fed is still very much accommodative

Tapering (the Fed is actually buying a total of $25 billion of bonds per month, while reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities, as well as rolling over maturing Treasury securities) is not Tightening.

Janet Yellen and Company (despite a few dissenting opinions) appear to be committed to their oft-repeated statement, "When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2%.

The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run."

6. Investor sentiment is far from euphoric

Doom and Gloom talk is still ubiquitous, with return of capital of greater interest to many investors than return on capital, despite a massive equity rally over the last five-plus years.

We continue to see outflows from actively managed equity mutual funds and inflows into bond funds, while sentiment surveys recently have been seeing waning levels of bullishness and rising levels of bearishness.

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