Time to make your stock shopping list

Fear and anxiety have driven valuations more than fundamentals, leaving some stocks at bargain levels.

By The Fiscal Times Jun 12, 2012 4:54PM
Image: Stocks circled in newspaper (© Digital Vision/Getty Images)By Suzanne McGeeThe Fiscal Times

There are plenty of reasons that the U.S. stock market should resume the rally so rudely interrupted a few weeks ago by underwhelming economic data and new waves of anxiety-inducing headlines from Europe.

Just ask the folks at Goldman Sachs (GS), who have yet to retract any of the arguments they put forth in a report published early this year entitled "The Long Good Buy." Stocks were clearly a "good buy," Goldman strategists argued, while investors should bid "goodbye" to bonds -- and that was before the yield on the bellwether 10-year Treasury touched a record low below 1.5%.

The Goldman folks have company these days. The analysts at Birinyi Associates recently published a note suggesting that stocks have been oversold and that what is likely to happen next is more likely to be stability than significant decline. That doesn't mean that the firm's analysts are recommending universal bullishness and suggesting investors buy everything in sight; rather, they urge avoiding obvious trouble spots (energy, materials stocks) and being highly selective in potential areas of weakness, such as financials.

Even the venerable Byron Wien, who at the beginning of the year had forecast that the Standard & Poors 500 Index ($INX) would climb above 1,400, remains bullish. "The best time to buy stocks is when people hate them and they sure hate them now," Wien says, according to Bloomberg News.

By any standard, stock market valuations are in the doldrums. The degree of risk aversion in the global financial markets has reached such extreme levels that broad markets and individual stocks with reasonably solid fundamentals are trading at levels that sometimes appear almost absurdly low. The MSCI Index for the United States trades at a mere 11.8 times prospective 12 month earnings, as Thomson Reuters Alpha Now noted this week. Canadian stocks are still cheaper, trading at 11.4 times prospective earnings; investors in Australia can find bargains with the overall market trading at 10.6 times earnings, and Dutch equities command a multiple of only 9.1 times. By any standard, these are bargain prices.

It isn't fundamentals that have driven markets down to valuations that are in many cases closer to 10-year lows than they are to than to 10-year highs, but rather fear and anxiety. To bulls, that kind of general anxiety is a great opportunity for bargain hunting -- even if the bears insist that there's a greater risk of a financial apocalypse taking shape in Europe today than at any time in the last 80 years. Each side views the other as irrational; the division of opinion, reflected in the market’s volatility, sometimes seem so stark as to make Washington’s political environment look downright collegial and bipartisan by contrast.

After all, stock market indexes respond to the level of investor interest in the individual stocks that underpin them. Many of the companies whose stocks trade on U.S. exchanges and who make up the key indexes are doing anything but standing still, even if their share prices don’t reflect it. Take Apple (AAPL), for instance, whose stock still trades at about $570 a share, or only about 14 times trailing earnings, despite the fact that it routinely posts blockbluster numbers and that it has been busy developing new software tools for the burgeoning mobile market and tying itself more closely to Facebook (FB). Many analysts believe the stock should be trading at or above $700 a share, reflecting its dominance of the smartphone and tablet computer markets; instead, it has fallen back from above $600 to trade at levels below where it was before introducing the latest version of the iPad.

True, the U.S. economy doesn't seem likely to grow as rapidly as economists had been forecasting; true, there are plenty of risks in global financial markets. But the biggest risk of all is the psychological barrier preventing investors from acknowledging that the fundamentals for U.S. stocks are relatively strong, and that there remain plenty of tailwinds. For instance, while the slump in energy prices may be bad news for companies in that sector, it’s good news for other businesses, whose costs will go down accordingly. And it's good news for consumers, who will now find they have more disposable income available to spend.

Of course, as we noted just last week, in market climates such as this, irrational investor psychology can trump fundamentals for prolonged periods of time. And we’re heading straight into what seems likely to be the biggest test of that this year: the Greek elections scheduled for this weekend. Unquestionably, some kind of chaos will follow.

But unless you believe that chaos will remain the norm for months and years to come, it’s worth spending the next few days drawing up your own wish list of stocks you'd like to own if they were only 5% or 10% cheaper. Odds are that they will be; and if you are really picking those stocks based on fundamentals, odds are that higher profits and improving businesses will mean that by the end of next year they will be trading at far loftier valuations than they command today. And that’s what investing is all about, after all: trying to gauge what might happen over the next 18 months to three years, rather than the next 18 days.

Suzanne McGee is a columnist at The Fiscal Times. Subscribe to The Fiscal Times' FREE newsletter.

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