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Taking Stock

Tony Crowell

The Worriers Are Wrong:

Stocks Are A Buy

The stock market endured what seems like a Biblical forty days of rain, depressing investor spirits. These dipped further on a crummy employment report and continued sliding in house prices. Pandering to public moods, politicians and pundits jumped in with prophecies of double-dip recession and eternal fiscal deficits. These reactions, although understandable, are overdone and the prophecies are wrong, less understandably.

Even after giving up 5% from its April high, the market is still up 3% this year and 25% since last summer. A 5-10% market “correction” is quite normal after a sustained advance and the current fidgeting is likely to be forgotten as stocks resume their climb from the lows of the financial crisis. Similarly, the most recent unemployment report was probably a one-month anomaly.

Investors seem to have overlooked the temporary problems in the US economy stemming from the impact of the Japanese earthquakes in March. In an increasingly interconnected world, this took close to a half million vehicles out of the US pipeline. Higher oil prices produced another headwind. Auto and technology companies are quickly resolving supply issues here while Japan is moving steadily, if more slowly. Oil prices have steadied and hardened consumers are adjusting.

Financial commentators screaming about doom are after viewers, not facts. Politicians spouting about deficits are seeking votes, not business recovery, as basic economics calls for stimulus spending, not cuts, to spur an economy. We may not get more spending in the present climate but forces now underway will bring a moderately stronger economy.

IHS Global Insight, a highly respected economic consulting firm, publishes an economic outlook index that currently forecasts GDP growth increasing to a 3.0-3.4% rate in the second half of 2011. This index combines 11 forward-looking indicators that IHS research believes have high predictive power.

Six were positive in May: building permits, capital goods orders, the yield curve, export orders, oil prices and the corporate bond spread. The four negative factors were hours worked, light vehicle sales, money supply and the real federal funds rate. The eleventh indicator, the stock market, was neutral.

IHS publishes the index at www.usatoday.com/money/economy/story/EconomicOutlook/35290148/1 The company (IHS-$85) is an excellent growth story with sales of $1.1 billion growing steadily at a 17% rate with earnings growing even faster. The P/E on 2011 earnings is 27, not bad, but I prefer to emphasize for the moment larger companies with lower valuations.

3M (MMM-$92) is growing at moderate single-digit rates but has a P/E of only 13. It also pays a 2.5% yield on dividends that it increases annually. 3M, like other export-oriented companies, is doing particularly well under current foreign exchange conditions for the dollar. IBM (IBM-$165) is similar with earnings growing even faster, priced at only 11 times forecast 2011 earnings, yielding 1.6%.

These two companies are representative of most of the members of the S&P 500 in continuing to grow earnings faster than their stock prices. As a result of the gloomy sound and fury in the media, valuations still remain remarkably reasonable for stocks and will probably become more reasonable in a few weeks with the next round of quarterly earnings.

Stock prices may languish during the summer, another normal trading pattern, despite even more compelling valuations. Meanwhile, stock analysts continue to raise their earnings estimates. Unless these estimates are all wildly wrong, the stock market is building a base for gains of 10-15% for the year, with strength becoming more recognizable with the fall.

Tony Crowell manages stock portfolios for individuals and their trust and retirement accounts with CROWELL•ROBERTS Investment Counsel, a registered investment advisor in Laguna Beach since 1993. [email protected] (949)494-1376/ (800)697-2622 www.crowellroberts.com

 

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