News & Insights
Optimism, U.S. Stocks and the Mountain of Cash
The big news of the past few months is the sea change in the character of the U.S. stock market. Since last July we have articulated a strategic position that one of the positives of investing in stocks was the moderately undervalued nature of the broad market. The extreme gloom of investors and numbers of stocks trading below their long-term averages added a contrarian boost to the argument to step into the waters and invest some of the idle cash in equities. A third and important factor supporting the constructive view on the market was the historic levels of cash sitting on the sidelines. Strategy was
strongly on the side of accumulating stocks.
Since the 2003 lows recorded in March, a lot has changed. A good deal of chronic undervalation that has existed since the summer of 2002 has evaporated and an emerging optimism has replaced the gloom of just a few month ago. The balance of investment strategists have switched from bearish to bullish. Cash levels have subsided just a bit and money has found its way into stocks in April, May and June. This represents to us the beginnings of at least a cyclical recovery in the stock market.
How High Is The Mountain?
The scale of the cash mountain is still enormous even though it is coming off Everest proportions. In 1982, at the beginning of a 17 year bull market and with stocks at depressed valuations, the cash in checking accounts, money market funds and bank deposits was equal to about 53% of the value of the entire stock market. In March of this year with stocks only moderately undervalued, cash on the sidelines was equivalent to almost 63% of the value of the stock market. Even after a 20% recovery in stocks since the lows, cash is still is valued at over 56% of the value of the market.
What About Stocks?
This money acts as fuel for the market's eventual rise. The recovery in stock prices will be assisted by this liquidity, by improving corporate profits (up 12% year over year last quarter) and an improving economy assisted by a determined Federal Reserve. The market will be constrained by the higher valuation now accorded shares since their March to June advance.
For investors, the strategy stays the same; emphasize stocks in a balanced portfolio. However, in July 2003 short-term tactics may deviate from long term strategy. The burst of recent optimism has pushed over 80% of the stocks on the New York Stock Exchange above their intermediate averages which, paradoxically, indicates to us that the stock market may tread water or even retrace some of the progress made since March. The difference between now and this time in 2002 is that market declines represent opportunities to add to stock positions.
Some sectors, such as technology have gotten ahead of themselves and will likely consolidate their gains. Traditional defensive havens such as consumer staples have languished as the incremental money flowing into the market has gone to growth areas such as technology and cyclical stocks in retail and materials. We believe a portfolio broadly diversified across sectors emphasizing balance sheet strength provides the right position from which to navigate the remainder of 2003.
Other Asset Classes
In bonds, durations should be kept short and the overvalued treasury market should be avoided. As evidence gathers on the improvement in the economy, bond prices can fall quickly and interest rates will rise "like a coiled spring" as fears switch from an unlikely deflation to a return to moderate inflation. Foreign shares in emerging and developed markets are still attractive relative to U.S. markets as are REIT's and so these should be considered in a diversified portfolio.
THE ALTAVISTA INVESTMENT TEAM- SUMMER 2003