5 Perspectives on the Market

October was one of the worst months on record for stock investors. We thought it appropriate to share our stubbornly contrarian point of view.

We actually see reason for conviction and sober optimism.  We encourage long-term investors to be taking action despite the challenges of these days. We are constantly on the search for compelling values, and these are typically found when others fail to observe or act in a rational manner. Thus, this period of irrational pessimism presents us with a rare opportunity to upgrade our portfolios, put cash to work, and position our portfolios for the eventual recovery of our economy and markets.

These are the observations that shape our view:

1.  Truly no ordinary bear market

Over the past 107 years, there have been 20 bear markets, meaning, on average, we've experienced a down market roughly every five years. A review of history shows that investors have previously endured tough times, and have always recovered.

2.  Unprecedented Government Stimulus

Although there are comparisons made to the 1930s, there is a distinct difference in governmental response. During the Great Depression, the Federal Reserve allowed the U.S. monetary base to flatline and raised interest rates. Today, the Fed is increasing the money supply, lowering rates, and has created a rescue plan for financial institutions.

3.  Attractive Valuations

As value investors, Heartland has always emphasized buying businesses that are selling at a discount to their true worth. This discount is a means to achieving potential appreciation while limiting downside risk. In today's bear market, we are finding a large number of companies selling at significant discounts to their true worth. In fact, 56% of stocks trade at a price to earnings ratio of less than 10x, a level not seen since the late 1980's.⁽¹⁾

4.  Trillions In Cash

Along with the attractive valuations in the stock market, investors hold a record amount of cash, including $4.5 trillion in money markets and small CDs.⁽²⁾  As confidence in the market returns, we expect a portion of this cash to be reinvested in U.S. equities, further supporting valuation. 

5.  Current Pessimism May Signal Reason for Optimism

The severity of the decline and intense volatility amplify investors' emotions. Pessimism is typically at its worst just as the markets are about to recover, a buying signal for contrarians.

What now? Maintain Long-Term Perspective

Although its easy to get swept up in the panic of the day, in light of the above, review your long-term strategy and make adjustments to be consistent with your investment goals. It helps to maintain a long-term perspective and remain invested. As shown in the chart below, gains have been significant during the three, six and 12 months following bear markets. Missing these months could result in reduced future returns over the long term. 

Source: Ned Davis Research. Study uses NDR-defined Bear market dates for the months in which those moves started or ended. Study is presented using monthly total returns and does not contain information for the current cycle. Small-cap total return data from Ibbotson prior to 1979, Russell thereafter.

⁽¹⁾ J.P. Morgan, October 17, 2008
⁽²⁾ ISI Group, October 13, 2008

Past performance does not guarantee future results. This hypothetical example does not represent the returns of any particular investment.