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Who had Egypt in the betting pool?
Seriously, whose list of risk factors for the global equity markets entering 2011 led off with the chance that popular unrest in the streets of North African nations would spur investors to back away from the risk buffet they'd been gorging at since about Labor Day? The typical guesses as the year started encompassed European debt dramas, Chinese over-tightening, runaway oil prices or another down leg in U.S. housing prices.
The thing is, in most market declines accompanied by worrisome headlines and unnerving TV footage, the news is merely an excuse and not a root cause of the selling. It's hard to point to geopolitical rumblings that truly marked important market turning points.
This was a market that was sleepwalking higher, buoyed by progressively more cheerful investor attitudes and the reallocation of cash into stocks by a radically underinvested public. Friday's 1.8% loss in the Standard & Poor's 500 index, and the appreciably larger drop in the Nasdaq and other faster-moving benchmarks, showed a market succumbing to short-term fatigue, below-the-surface deterioration and some concerns about the loss of economic momentum in the States. There could be more of the like to come now that the tape's illusions of invincibility have been disproved, though it won't necessarily evolve into anything terribly nasty.
Weeks after venues such as this column began fretting over the unfortunate welling up of investors' animal spirits, as measured by surveys, options-trading data and the like that showed collective optimism on the rise, those gauges have begun to moderate. This hardly means some great tactical buy signal has emerged, but it's better to see more grins turning to frowns as the market treads water than the reverse. It's also not unusual to see stocks run into some static during earnings-reporting season.
Yet in the latest snapshot of hedge-fund positioning, Robin Carpenter of www.CarpenterAnalytix.com shows equity exposures flirting with the top 20% of all weeks over the past several years, which is a caution flag but not in itself a cause for radical moves. The Ned Davis Research "cycle composite" study, which blends the one-year, four-year and decennial historical market tendencies into one chart meant as a rough guide to a year's stock-index trajectory, has worked rather well the past couple of years. For 2011, it implied a strong January, then some back-filling, followed by another run higher, with essentially all of the year's (modest) upside coming in the first half.
Stocks are neither terribly cheap nor dauntingly expensive. The median price/earnings ratio of all 1,700 stocks in the Value Line universe was 17 at last report, versus 10.3 at the March 2009 market bottom and 19.7 at the last bull-market peak. Yet valuation is more scenery than script.
Corporate financial engineering (see ITT [ticker: ITT], Fortune Brands [FO] and Sara Lee [SLE]) and the ebb and flow of investor psychology will dictate the market's immediate future. A stockpicker's market, anyone?
STUFF, PLUS SMARTS. THAT'S A DECENT shorthand description of the business strategy of Brookfield Asset Management (ticker: BAM), whose opportunistic and value-driven management invests the company's own capital alongside that of institutional clients in infrastructure and real-estate properties.
Perhaps the premier manager of real assets, the Toronto-based but globally diverse Brookfield deserves a higher public profile. Its shares have handily outperformed the broad U.S. stock market for the past one, five, 10 and 20 years. The stock's run from the low 20s last summer to the current quote of 32.35 may appear to mean that market perception is outpacing corporate progress, but in fact the shares trade at only a fractional premium to the company's tangible net asset value, which at last report was $30.99 as of Sept, 30, 2010.
Brookfield was in the news recently for having added to its large stake in mall operator General Growth Properties (GGP) by purchasing a block from the top-performing Fairholme Fund (FAIRX) for a mix of cash and stock.
The deal, just completed, raises Brookfield's stake in General Growth to 38%, or about $5 billion at recent prices, a large chunk of Brookfield's own $19 billion market value. That Fairholme has elected to accept and retain a 4.5% slug of Brookfield in the deal is not insignificant.
Brookfield is not the simplest company to analyze, with assets as diverse as electricity transmission grids in South America, hydroelectric plants, port facilities and New York's World Financial Center. And the company is not starkly cheap based on reported earnings, which are expected to hit $1.12 a share this year. But the combination of proven management and the undeniable trends of greater private infrastructure ownership, emerging-markets economic growth and investor demand for nontraditional assets make Brookfield a strong long-term holding.
E-mail: michael.santoli@barrons.com
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