Fall Letter To Clients Part I

Sell In May......

Stock spent much of the summer doing nothing. I alluded to that possibility in my spring letter:

“..{O}nce the markets find some level of equilibrium stocks could go to sleep for perhaps 4-5 months as they digest the last year's gains. The old phrase "sell in May and go away!" could be on target this summer and stocks could be range bound until the leaves turn color in the fall. A rest while stocks churn about in a trading range could set the stage for better opportunities later in the year.”

From a late April high to its June low, the S&P 500 declined almost 17%. Stocks spent the rest of summer building a base and began rallying around Labor Day. The market has advanced about 14% since. Year to date, the market according to Morningstar has gained about 7%.

Stocks have spent much of the year caught between positives such as attractive valuations, excellent corporate balance sheets and relatively high dividend yields. In addition the earnings yield (the inverse of the PE average) has traded much of this year between a 7% & 8% yield. A ten year US treasury by comparison currently yields 2.71%. {Source: Bloomberg}

A brief aside on bonds: Basically current yields say investors are so unconfident about future growth that they will accept after tax rates of return significantly below what will prove to be the likely inflation rate. Right now Treasury TIPS-inflation protected bonds-carry a NEGATIVE yield! Bond professionals though are becoming nervous. Particularly, they worry about the Federal Reserve’s reputed plans to inject possibly up to a trillion dollars into the economy in order to fight the effects of deflation. PIMCO’s Bill Gross stated yesterday that the 30 year old bull market in bonds will be over if this happens. http://www.bloomberg.com/news/2010-10-27/fed-easing-likely-to-mark-end-of-30-year-bull-market-for-bonds-gross-says.html.

The negative side is that investors are concerned about slowing growth. Economic forecasts have been steadily lowered this year. Unemployment remains high, populist policies enacted by the President and the Democratic Congress have confused business leaders and made them reluctant to spend and hire.

Inflection Point!

May’s “Flash Crash" seems to have been an inflection point. Investors, perhaps finally tired of a lost decade of equity investing, seem to have collectively said "To heck with this!" Individuals have been net sellers of stocks for the past two years but that pace quickened after May. This autumn’s rally seems to have rekindled some interest in the markets. However, cash inflows into bonds and fixed income mutual funds has far outstripped that going into stocks which have shown withdrawals in every month this year.

I think this so called inflection point will be a mistake for many investors. Based on what we know today, I think stocks will produce at least trend line gains the rest of this decade. While I don’t expect markets to go up in a straight line, I do believe the overall direction will be positive. I will explain why, covering the shorter term period first and then briefly state why I think technological advancements should help the market head higher longer term.

Now I know I can be accused of "talking my book" because obviously I do better if stocks go up. My response is that I am paid to invest assets based not only on their clients individual risk reward criteria as I understand it, but also how I perceive the investment field to be tilted. With interest rates on bonds and CDs at historic lows, I think that balance today favors stocks.

Below:  Why the elections should be positive for markets.

*Long ETFs related to the S&P 500 in client accounts.