We are sitting here, wondering how much longer irrational fear will be able to restrain the forthcoming market surge we expect. Looking at the balance sheet between risk and reward insofar as the U.S. equity market is concerned, what we see is the following:
Risk
1. Hysteria, panic, mindless fear
continuing to restrain rally;
2. Apocalypse -- which we deem unlikely
in the extreme;
3. Depression -- which we deem to stand
at the outermost limits of remoteness.
Reward
1. Lowest absolute S&P 500 valuations v. forward earnings in nearly 20 years;
2. Equity valuations relative to interest rates as cheap as any time in past 30 years;
3. Declining rate cycle SOLIDLY established;
4. Contrarian signs -- ie. media panic-mongering, bearishness, and investor sentiment at levels more characteristic of major bottom than major top.
We expect value to assert itself in no uncertain terms as soon as hysteria starts to abate. Clearly, the smart money is buying like there is no tomorrow. Despite all the brouhaha about the current sovereignty of risk aversion, we note with interest that smartly-managed foreign liquidity pools (e.g., Temasek, the Singapore sovereign wealth fund, Chinese money pools, and Middle Eastern big money) are placing VERY RISK SENSITIVE BETS in the multi-billion dollar class. We doubt that anyone in his right mind would consider the debt-overloaded financial goliaths to remotely resemble a blue chip investment, yet this is a prime location to which the smart foreign money is headed.
As for the current state of the equity market, our view is that a strong base is being formed in the wake of recent successful testing of the August market low. We expect that in due course the market will move up in a very impressive manner, sparked as always by falling rates which are daily diminishing the attractiveness of their fixed income competitors. Declining rates, a presidential election year, and the unlikelihood of depression -- what more could a careful investor desire?
