Yes, the financial news gets worse every day. Yes, the average stock is down more
than 25% over the past thirteen months. Yes, the housing market is still reeling and
foreclosure activity is rising. Yes, the price of gas is skyrocketing. And yes, this too
will pass, and the economy and stock market will begin a new expansion and
sustainable bull market, as all business cycles have. Over our several decades of
investment management experience, we have witnessed many business cycle
recessions and stock market declines. They all have one thing in common. In the
midst of the most negative financial news, the stock market (fulfilling its role as an
accurate leading economic indicator) begins to move higher in anticipation of the
next economic recovery. We believe the market has more than discounted all
the bad news out there and is putting the finishing touches on the bottoming
process for stocks. Yes, a significant advance is set to begin that will take stocks
much higher in the year ahead.
Considering all the negative financial headlines, is it any wonder investor psychology
has reached a gloomy extreme? Legendary value investor and philanthropist
Sir John Templeton made a career (and fortune) taking advantage of bargains that
showed up during recessionary periods and bear markets. His foremost investment
discipline was geared to wait patiently for stock prices to “reach the point of maximum
pessimism” and then he invested. It is somewhat
ironic that this pioneer of value investing, who
began his career in the 1930’s, would pass away
this month at the age of 95, just when the markets
have hit an emotional low point. We know Sir John
would be buying stocks during today’s financial
turmoil. Investor psychology has reached that
pessimistic extreme and conversely sets up the year
ahead to be a very profitable one. In the remainder of this newsletter, we expand on
four potent reasons to support our forward-looking optimism.
FOUR KEY REASONS TO BE OPTIMISTIC TODAY
1. Low Consumer Confidence = Profits Ahead
2. Bull Markets Always Follow Bear Markets
3. Lower Oil Prices Ahead
4. Record Cash Levels on Sidelines
“Bull markets are born on
pessimism, grow on
skepticism, mature on
optimism, and die on
euphoria.”
Sir John Templeton
1600 S.
Reason #1: Low Consumer Confidence = Profits Ahead
This may at first sound a bit counterintuitive, but the good news is American consumers’ level of
confidence has reached a 28-year low. How can that possibly be good news? In the 40-year
history of gauging consumer confidence, whenever attitudes tumble to this pessimistic extreme,
stocks have already greatly digested and discounted the bad news. As detailed in the chart and
table, we have identified six prior times when consumer confidence had fallen to this extreme
low level. Each time, despite all the bad news, a new bull market for stocks began and
significant stock market gains followed. We expect this seventh episode to end profitably as well.
Reason #2: Bull Markets Always Follow Bear Markets
To add perspective to current market conditions, we have compiled information summarizing
past bull and bear market cycles since 1960. Since then, there have been 11 bear markets with
each followed by new long term bull markets. Please take some time to study the table of information
on the accompanying page, particularly the “News Events of the Day” column. There are
two key points about bear markets we would like to highlight: First, investors are always faced
with intensely negative news and many times a “crisis atmosphere” which pushes stock prices
temporarily lower; second, bull markets begin in the middle of all the bad news. Historically
the bull markets rewarded investors with gains on average exceeding 90%.
Reason #3: Lower Oil Prices Ahead
$40
$3
$145
Major Positive Surprise – Lower Oil Prices Ahead!
$11
?
$145
$40
$11
$3
Crude Oil
A major factor influencing consumer pessimism is oil prices have doubled in the last year. At every
level of spending, consumers are feeling pain of higher energy costs, whether it is filling the car up
with gas or buying groceries. Any relief from spiraling energy costs would be a major step toward
improving investor psychology. Looking at our chart of the 120-year history of oil prices, clearly the
recent price gains are at unsustainable levels. The chart depicts oil prices and our long-term momentum
tool (6 year rate of change) showing only two other times in history oil prices have been this
stretched. Each time was followed by a significant price decline. While others are projecting $200
oil, our tools and research suggest an important turning point forecasting lower prices. We think
the most likely outcome will be a significant decline in oil to $100 or lower before the year is
over. This positive surprise for investors will be a major catalyst for the next bull market lift-off.
Reason #4: Record Cash Levels on Sidelines
Ratio of Cash to U. S. Stock Value
Money Market
Funds $3.36 Trillion
Total Value $12.39 Trillion
U. S. Stocks
or =
Cash to Market Value at 27%
is the Highest Level Ever !
Fuel for Bull Market Liftoff
Another positive sign is the enormous cash pile investors have sitting in money market funds.
This record amount of cash is fuel for the next bull market advance. In fact, cash levels in money
funds as a percent of the total value U.S. stocks equals a record high 27%! This level is higher
than the start of any bull market of the past 30 years. A little improvement in the news, an end
to the oil price spike, and a shift in investor attitudes toward optimism will open the floodgates
of money fund assets flowing back into stocks. A virtuous cycle can begin once again.
Conclusion
In this expanded newsletter we have laid out four key reasons to expect a strong stock market
going forward. Consistent with our January newsletter message, we expected 2008 would be a
transition year from bear market to new bull market. We have arrived at that important transition
point. History shows that just as day follows night, bull markets always follow bear markets. Itis time to be optimistic!
