A Common Sense Approach to Investing

by David C. Blough, CFA, Senior Vice President & Investment Manager  

“Common sense is genius dressed in its working clothes”  - Ralph Waldo Emerson

Are we in another stock market bubble? I have been hearing that question repeatedly in recent weeks. It seems that television’s talking heads like to promote doomsday headlines and stories to garner attention and advertising dollars. 

Investment professionals must use experience and thoughtful research to make good decisions. Our goal is to reduce emotion and to employ reason when investing our client’s resources. We take into account, their investment objectives, ability to cope with risk (price volatility) and needs for income today versus growth for tomorrow. The end goal is a steady long-term point of view that makes evolutionary rather than revolutionary tactical changes in the short term that can improve long term performance. The goal is ongoing progress in all types of market environments.

With that in mind, I will attempt to respond to the bubble question. Bubble’s typically occur in an over-heated economy, accompanied by investor speculation. I don’t see either at this stage of the business cycle. Without question, investors have been rewarded   with outstanding stock market appreciation this year. Furthermore, the longer-term stock market advance experienced since the March 2009 lows, reflects major improvements in the U. S. financial system (Wall Street) and a slow but steady rebound in U.S. economic activity (Main Street).

While all is not well, the patient is out of intensive care and continuing to grow stronger as time goes by. Doctor Bernanke and the U.S. Treasury administered CPR to reverse a faltering heart. The Fed used stimulants to raise the economic pulse and long term medications to reverse the damage caused by an imploding mortgage market. Like any critical patient, the treatments don’t work over night. Patience and determination has been necessary during the long recovery process.

We do not think the stock market is in a bubble. Real GDP may increase by 3% or more next year, the best growth since 2007. The last four years have seen anemic 2% growth rates. Faster growth will likely provide higher corporate profits. Corporate balance sheets are much stronger and cash balances are plentiful. This has led to significant dividend increases and stock repurchases. Both have been strong pillars that have supported rising stock prices. Market valuations are still reasonable at 16 to 17 times 2013 expected earnings per share. That’s far below the tech bubble’s 28 times price-to-earnings ratios in the year 2000.

Energy Game Changer
The United States is expected to surpass both Russia and Saudi Arabia in oil production by 2015. “Fracking” oil shale is controversial but the affect on U.S. oil and natural gas production has been incredible. It now appears possible that the U.S. could achieve energy independence within ten years. Contrast that to the year 2000 when the U.S. was forecast to produce less than 50% of the energy it was consuming. The large increases in energy production over the last three years and further increases projected in the years ahead are providing the U.S. with bargain basement natural gas prices. The cost of natural gas to heat our homes, as well as to produce electricity, has plummeted to about one-third the cost of this precious commodity in Europe, China and Japan. This will provide the U. S. with a major cost advantage going forward. In particular, chemical companies, which use natural gas for feedstock in making a huge variety of products from plastics to fertilizer, are building new facilities in the U.S. and bringing foreign production back home. We could well be in the early stages of an industrial renaissance after years of decline.

For a common sense approach to your investments, come see United’s Wealth Management Group.