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When Opportunity Knocks, Are You Ready?
By Ernie Ankrim
Chief Investment Strategist, Russell Investment Group
Global Leaders in Multi-Manager Investing
April 13, 2004
This article has been provided by our parent company, and any references to rates or returns are based in $US and specifically relate to US markets.
There's no doubt that many investors still have legitimate concerns about global terrorism, corporate scandals, slow job growth and dragging consumer confidence. These issues propelled corrective behavior in the broad US equities market as the Russell 3000® Index dropped 5.81% from March 5-24. In comparison, the S&P/TSX Composite Index fell 2.2% over the same period.
But I believe that for disciplined investors, these moments of fear or despair can represent real investment opportunities — if we are willing to expose ourselves to the risk of equities.
Where is This Market Headed?
Before I got too optimistic about the corrective behavior, I wanted to figure out just what kind of market we were in. Were we at the beginning of another decline or simply suffering from the routine kind of "market angst" that occurs even though underlying fundamentals are still positive?
I identified two other points in time when the US equity market had last been at its current level: May 23, 2002 and December 26, 2003. What was going on in the market then? Were there any signs that might help me determine whether equities represented a favorable investment opportunity based on the recent past?
Looking for Signs
First, I compared existing US interest-rate levels for A-rated securities. Interest rates are relevant not only because they represent an alternative investment — we can always buy bonds rather than invest in equities — but also because they can be used to calculate the discounted value of future earnings of a stock or stock index. The higher the interest rate, the lower a company's or index's value.
I then looked at analysts' expectations for earnings generated on the S&P 500 for the next 12 months. While these expectations sometimes turn out to be wrong, on average they indicate what shareholders might reasonably expect in the way of corporate profits for the coming year.
Falling rates, rising earnings expectations point way to opportunity
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05/23/2002 |
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12/26/2003 |
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03/24/2004 |
| S&P 500 |
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1096 |
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1095 |
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1093 |
| Corporate A rates1 |
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7.41 |
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6.1 |
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5.8 |
| Earnings expectations2 |
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$52.90 |
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$61.00 |
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$62.30 |
1 As represented by the Moody's A-rated bond index.
2 Source: Bloomberg, Calendar-weighted value of "Zacks Most Accurate Forecasters" for years ending 12/04 and 12/05
In this particular situation, I found that while interest rates have dropped since both May 2002 and December 2003, earnings expectations have risen rather dramatically, from US$52.90 in 2002 to US$62.30 as of March 24. So equity prices at this point should be higher than they were nearly two years ago or even three months ago. Yet the S&P is at almost exactly the same level.
Hmmm ... better expected earnings and lower interest rates, yet no movement on average stock prices. That certainly looks like a compelling investment story to me.
Fearing Fear Itself
Now I'm not saying that this is a once-in-a-lifetime opportunity or that investors should run out and sell their cars in order to buy stocks. But if, in fact, the benchmark retreat may have scared people into believing that the market was about to give back all its gains, then I would caution them about getting too frightened too quickly.
It's funny that when prices decline, investors get scared away from buying stocks. But, paraphrasing Warren Buffett: "If I go to the grocery store and meat is on sale, I buy steaks. When prices go up, then I buy hamburger." Think of this as a filet mignon market moment. Prices have fallen, yet the fundamental reasons for owning stocks look attractive.
I know it's tempting to give in to fears of the moment. But, I believe, now really is the time to make sure you have the right amount of equity exposure in your long-term investment strategy. When opportunity knocks, you really do want to be in a position to open that door.
Copyright© Frank Russell Company 2004. All rights reserved. See Important Legal Information. Date of first use: 4/13/04.
This is a publication of our parent, Frank Russell Company. It should not be construed as investment, legal, or tax advice. The contents are intended for general information purposes only, and you are urged to consult your own investment, legal, or tax advisor concerning your own situation and any specific investment questions you may have. For further information about these contents, please contact Russell Investments Canada Limited.
Russell Investment Group is a registered trade name of Frank Russell Company, a Washington USA corporation, which operates through subsidiaries worldwide. Frank Russell Company is a subsidiary of The Northwestern Mutual Life Insurance Company.
S&P 500 Index: An index, with dividends reinvested, of 500 issues representative of leading companies in the US large cap securities market (representative sample of leading companies in leading industries).
Indexes and/or benchmarks are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.
Frank Russell Company and Standard & Poor's Corporation are the owners of the trademarks, service marks, and copyrights related to their respective indexes.
RC 3824
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