Summer 2013 Investment Letter {Part II}

Here is part II of our latest investment letter to clients:

Foreign markets have been impacted by a wide variety of factors, everything from slowing growth in China, Europe’s continued debt issues, tensions in the Middle East and stagnant economies in Latin America.   Reflecting this uncertainty, most foreign stock markets have seen little share price appreciation in the past few years.  As such, these markets are looking increasingly attractive to us.  A combination of what we think will be improving economies over the next few years and attractive valuations are increasingly reminding us of how our markets looked over a year ago.  In addition to being cheaply priced many of these markets in the form of ETFs pay attractive dividend rates, which in essence allows you to be paid to wait for an upturn in their fortunes.  Expect to hear more about this from us going forward.

Here at home stocks indices have been recently making new highs and currently trade with a forward PE ratio closer to 16% and an earnings yield of 6.3%.  This is near the upper end of our investment range.  We discussed in our winter letter that our target range {or what we refer as the cone of probability} for 2013 was for equities to trade between 1,490-1,700 on the S&P 500. As of this writing the index trades about 15 points away from what we suggested might be the high end of this range.  This is of some concern to us.  We are mindful that at these levels stocks are perhaps more priced for perfection than we have seen in some time.  We also know that while we are generally positive on the economy there are many troublesome aspects that could at some point surface to worry investors.  One needs only to look at how markets recently reacted to news that the Federal Reserve might slow its purchase of bonds to see what could happen when negative news surfaces at these valuations.  On the other hand, while stocks are certainly not as cheap as they were a year ago or even last winter, they are trading within historic ratios for expanding economies.  If one looks out towards 2014 then stocks are trading with a PE between 14-15 and an earnings yield between 6.5-6.7%.  This is also against a backdrop where interest rates are still at historic lows. Stocks have had the wind at their backs and given that we are in a seasonal period where markets often exhibit weakness we will watch carefully to see what happens.  It is possible of course that we could see a correction with an unlooked for event being the catalyst to a decline.  Stocks could also simply mark time for a bit. The August to mid-October period is statistically the weakest investment period of the year so we would not be surprised if markets are range bound to slightly negative going into the fall.  But, this could potentially set us up for a nice end of the year rally sometime after Labor Day.  

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