Don't Get Spooked Out of This Market

After gains of more than 35% for the S&P 500 in the past 17 months, it's easy to get spooked any time the market has a few days or weeks of retreat. What makes matters worse is that many newspapers and business media bring out the bears or focus on bearish stories at the first sign of market weakness, bad news or overhangs. The vast majority of those times, it's easier to sound smart and create a negative case about the problems of the world, the economy or the market than it is to be bullish. Bearishness focuses on identifying the problems or uncertainties that are present in every market environment and assumes that they don't get resolved. That overwhelms the positives. Conversely, being bullish requires discounting or overlooking the problems or believing they can be successfully addressed, having conviction that the positives will win out. Often times that optimism seems like pie-in-the-sky thinking. Bearishness on the other hand, sounds like an objective tell-it-as-it-is analysis. Last Friday morning, one of the business news anchors voiced fears that, with the market down on Thursday and pre-opening futures looking lower, it could set the stage for a big Monday selloff. He noted that a lot of big market crashes started with this one-two-three punch. Earlier this week the Wall Street Journal ran a story titled Corporate Earnings Leaves U.S. Shares Wobbly that rehashed the first quarter's earnings season. The theme of the story was that most companies beat analysts' estimates, but only because expectations were very low. It went on to say that profit gains were anemic at 2.1%, and that spelled doom for U.S. stocks. While that is factually correct, we believe the story's implication was wrong. Slow earnings growth has usually been good for stocks. So the slow growth for one quarter, in and of itself, is not a death knell for the market by any means. While we are aware of the many market overhangs and have concerns about individual companies, the future of interest rates, geopolitics, and global economic growth, overall we think the general environment is constructive for stocks and believe the positives meaningfully outweigh the negatives. We are still looking for a positive year for stocks (around the historic average gains of 9-11%) and look for a lot of bumps along the way. In this type of environment, individual security selection will be more important than it had been during the prior period. Our bullish outlook is driven by the following: The U.S. economy is entering a self-sustaining recovery. While the global economy has some issues, we believe Europe is in the early stages of a recovery and China is still showing reasonable growth. U.S. companies are doing very well on average and their managements' outlooks and tone are the most favorable they've been in a long time. We don't expect Washington to do something stupid and cause a new self-inflicted wound, at least until after the new Congress is seated after next year's November's mid-term elections. Valuations are still reasonable with stocks selling at 15.8 times 2014 estimated earnings and 14.2 times 2015 estimates. These are around the historic averages, and are especially reasonable in a low inflation, low interest rate environment. The positive outlook from corporate managements and boards is translating into accelerating M&A activity and better corporate spending. We expect M&A activity, shareholder activism, and boards placing a greater emphasis on capital allocation and shareholder value to be positive drivers of stock prices as the year progresses. We are aware of the many factors that can derail the U.S. or global economy and of the many geopolitical issues, and we don't take them lightly. But we think that we will muddle through them and that the favorable fundamentals outlined above will ultimately carry the day. Our best investment advice continues to be stay the course, don't get spooked out of the market during the selloffs and don't chase the market after rallies. Based on what we know now, we continue to suggest buying into periods of weakness. While the market is selling close to its highs, two groups that we like and that have had mini-pullbacks are financials and industrials. We would add to these stocks in the aftermath of their recent weakness, as we believe both sectors will have a strong back half of the year. Some stocks in these sectors that we like here are: JPMorgan Chase (JPM) Morgan Stanley (MS) State Street (STT) Charles Schwab (SCHW) DuPont (DD) Eaton (ETN) Johnson Controls (JCI) TE Connectivity (TEL)

Don't Get Spooked Out of This Market

Don't chase the market after rallies. Do buy into periods of weakness.

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