Investors are Losing the Forest for the Trees

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One should not take one’s eye off the critical issues that are likely to last longer than traders’ ever shortening time horizons.

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By Richard Bernstein | Posted: 10-29-09 | 11:42 AM | E-mail Article

The stock market's recent pullback has beta-investors (read: hedge funds) scrambling. However, one should not take one's eye off the critical issues that are likely to last longer than traders' ever shortening time horizons.

The Fed will likely be on the sidelines for longer than is currently expected. Many investors continue to worry about whether the Fed should or will tighten monetary policy. The 3-month T-Bill, at 6 basis points this morning, is screaming that the Fed should not and will not tighten. The Fed will tighten when credit growth begins to accelerate. The excessively low bill rate is a very good signal that such credit growth is not occurring. Bill rates lead the Fed, which is always late to the game.

De-coupling remains a myth. The de-coupling theories just won't die. The emerging markets have simply been high beta investments, and they continue to be so. The global economy was strong and emerging market stocks were champions. The global economy then went into recession, and emerging market stocks were goats. The global economy has been recovering, and emerging market stocks are again leading the way. Note that many emerging markets have suffered more than the U.S. during the downturn of the past couple of weeks.

Low-quality stocks. I find it somewhat amusing that investors love emerging markets, but greatly dislike lower-quality U.S. stocks. It's the same effect, guys! Low-quality stocks typically lead coming out of a recession, and they are doing so again exactly as history would have suggested.

Corporate profits growth might boom in 2010/2011. Reported profits growth hit a low of about -90% during the depths of the profits recession. It is highly unlikely that profits growth a year from today will be -90%. As I have pointed out for several months, it appears as though investors may be underestimating the operating leverage within the overall economy. The profits cycle has been increasingly booming and busting over the last 20 years. Both the peak and trough growth rates have been getting more extreme. With the bust resulting in a reported profits growth rate of -90%, it seems to me that this cycle's profits growth upturn is likely to surprise investors with its strength.

Value strategies look preferable. One might discount the earlier profits comment, and claim that growth is simply a result of easy comparisons. Of course it is. However, history shows well that value strategies are more likely to outperform growth strategies as profits growth improves, even if growth does not turn positive.

Financial regulation is coming. It could be huge. Everyone should read John Kay's column in yesterday's Financial Times. I have previously suggested that Wall Street's hubris regarding compensation would backfire, and invite heavier financial regulation. With unemployment at nearly 10% and small business lending in the dumps, it is getter harder and harder for politicians to rationalize that TARP money should ultimately go toward seven-figure compensation and currency and commodity swaps.

The consumer isn't the consumer, but is still the consumer. The secular outlook for the U.S. consumer remains terrible, in my view. However, one must be careful not to confuse the secular problems with potential cyclical improvement. Initial jobless claims and consumer discretionary stocks have historically had a very strong inverse relationship. If employment improves, consumer cyclical stocks tend to appreciate.

Don't get caught up in the near-sightedness of whether the market is going to have a correction or not. Longer-term issues like those outlined here are much more important to building wealth than is trying to gauge the market's every wiggle.

Richard Bernstein is CEO of Richard Bernstein Capital Management. He was previously the Chief Investment Strategist and Head of the Investment Strategy Group at Merrill Lynch. He has written two books on investing: Navigate The Noise: Investing In The New Age Of Media And Hype and Style Investing: Unique Insight Into Equity Management.

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