Wednesday, March 13, 2013

"Should I Be Selling Stocks Now?"

The last few days have been one of the busiest times I have had in the business.

Clients have been calling and/or emailing about the markets.  And the most popular question (by far) is:

"Shouldn't we take a little off the table?  Stocks have come a long way in a short period of time, and the economy still seems shaky. Aren't we due for a significant correction?"

There is no question that sentiment has turned positive on the markets. Here, for example, is an excerpt from a piece published this morning by Merrill Lynch:

Investors Intelligence (II) % Bears moves to 18.8% and to a contrarian bearish level below 20% for the first time since April/May 2011.
I went to hear Savita Subramanian, chief equity strategist at Merrill, to hear her thoughts.
I have a lot of respect for Savita's work.  She takes a very disciplined, largely quantitative approach to the markets, and presents it an readily understandable fashion.
Savita has long had a target of 1600 for the S&P 500 by the end of this year, which would represent only another +3% or so further upside from today's levels.  That said, I got the sense that she would not be inclined to sell stocks at today's levels for some of the reasons listed below.
Here were the highlights from our meeting yesterday:

  1. Most of the clients she has visited with recently are looking for a correction of at least -5% or so in the near future. Savita views this as modestly bullish, since it means that there is significant cash on the sidelines looking to get into the market;
  2. She is more bullish than most on stocks of companies with significant business exposure in Europe.  Their work indicates that European sentiment is far worse than actual business conditions, which represents an opportunity;
  3. Her price target of 1600 is based on fairly muted economic expectations.  Using 6% EPS growth (below recent history); no margin expansion; and modest GDP growth (around 1.5%), she derives $110 EPS for the S&P by the end of 2013.  Applying a 14.5x multiple (also slightly below historic averages) gets you to 1600*;
  4. Merrill is more bullish on small cap stocks than most. Savita listed three reasons. First, they believe that the large amount of corporate cash reserves will be put to work in M&A activity, focusing largely on smaller companies.  And, second, if the economy surprises on the upside (i.e. does better than expected), small cap stocks will benefit more than larger stocks.  Finally, if the market continues to show a good tone, managers of larger cap funds will begin to move down the capitalization scale in search of more beta;
  5. Utilities and telecom sectors are the most overvalued areas in the S&P 500 based on a comparison of current valuation to historic averages. That said, as long as bond yields stay low, it will be less likely that we will see any significant changes;
  6. Meanwhile, healthcare and technology screen as the most attractive areas for investors.  Energy too offers value. 
Finally, Savita noted that for investors with a longer time horizon - 10 years or so - it is hard to find any area more attractive than stocks starting from today's valuation levels.

From 1929 to the present, stocks have had a positive total return for 94% of the rolling 10 year periods.  Starting from today's valuations, she has not found any period where investors lost money over a 10 year period.

The risks to Savita's outlook generally revolve around macro economic events.  A nasty surprise from the political discussions in Washington; another bout of euro block crisis; or a significant slowdown in China or the emerging markets would all cause her to re-evaluate her current stance.  

*extending Savita's numbers to 2014 gets you to an S&P EPS of $121 by the end of 2014. Using the same 14.5x multiple, this would imply the S&P could be at $1750 by the end of 2014.