Six Things I Love About This Market

Bob Froehlich Hartford Investor October 14, 2011

There are a lot of things I love in life—one of them is our stock market. I know this might sound pretty crazy because most investors hate our stock market, while I actually love it right now. Speaking of love, I'll never forget when I first heard the song, "Love Changes Everything" sung by Sarah Brightman. My wife, Cheryl, and I were on a cruise sailing across the South China Sea from Hong Kong to Japan in some of the roughest waters we've ever witnessed. This memory reminds me not to focus on things over which I have no control—like the rough South China Sea, or volatile swings in the stock market.

So what is important to focus on in our stock market today? I'd begin by focusing on the six things I really love about our markets: earnings, balance sheets, a market that's on sale, an accommodating monetary policy, a weak dollar, and nervous money in cash. Let me briefly touch on all six, beginning with earnings.

The thing I love most about our market is earnings. Believe it or not, we have "good" earnings. While the term "good" may appear subjective, it actually has three attributes. First, earnings have to be coming from a broad base of different industries and sectors, which is exactly what we have today. Technology, health care, industrial companies—and heck, even the automotive companies are now making money. Second, these companies have to continue to consider the "bottom line" by focusing on cost cutting and making productivity improvements, which is exactly what's happening today. Third, and finally, we also need to see some top-line sales and revenue growth which, over the past six months, we've finally started to see.

Not only are these earnings "good," they're the best in my 34-year career. While there are numerous ways to measure earnings and profits, one of my favorite ways is to look at profits as a percentage of the economy—especially when you want some historical comparison. Luckily, the Bureau of Economic Analysis does this equation for us on a quarterly basis. For the second quarter of 2011, corporate profits accounted for +10.1% of our economy as measured by gross domestic product (GDP).

How good is this profits number? For starters, it's the single highest profits number in my entire 34-year career. In case that isn't impressive enough for any of you history buffs, I'll add one more thing. The Bureau of Economic Analysis has been recording these quarterly profit numbers as a percentage of GDP since 1947. Our most recent number, which placed corporate profits at +10.1% of GDP, isn't just the highest it's been in my 34-year career, it's also the highest in the 64 years of tracking this data. That's why I love strong earnings.

The second thing I love is strong balance sheets. Once again, these are the strongest corporate balance sheets that I've seen in my entire 34-year career. The single best measure for corporate cash is called "U.S. nonfinancial corporations' liquid assets." In the most recently released numbers for this measure during the second quarter of 2011, cash is up 19.2% on a quarter-over-quarter basis. Over the past two years, this cash has increased by $700 billion to more than $2 trillion—the highest level ever recorded.

Looking at it another way reveals another all-time record high. Corporate cash as a percentage of our economy, a measure called "U.S. nonfinancial corporations' liquid assets percentage of GDP," came in at +13.8% for the second quarter of 2011, which is the highest number ever recorded. That's why I love strong balance sheets.

Third, having been taught by my wife and two grown daughters, I only buy things on sale. Guess what? I thought our market was undervalued when the Dow Jones Industrial Average1 was at 12500. Now it's really on sale—even better than the K-Mart Blue Light Special. However, most investors want no part of it. It's strange how the only thing people don't want to buy on sale is our stock market.

When you go to buy a car and see a giant "SALE" sign on a brand new car, that's your first stop. When you need clothes, you look for a sale. And what about real estate? Are you kidding me? You'd never say, "Oh my gosh, that $250,000 home is now selling for $200,000—something must be wrong. Let's wait until it goes back up to $250,000, and then we'll buy it." While no one would ever do this, it's exactly the way many investors buy stocks.

Everyone wants to "buy the dip." However, when we get a chance to "buy the dip," we don't. Remember, you're supposed to buy low and sell high. So what does "low" look like? It looks a lot like today. While that doesn't mean our markets can't go lower, it does mean our markets are on sale right now from that 12500 level. That's why I love a stock market on sale.

The fourth thing I love is an accommodating monetary policy. While that sounds like a mouthful, what it really means is that it would be very nice to have really low interest rates (monetary policy). Interest rates at zero would be good, and then keep them there for the next two years or so. Why is this important to our stock market? Well, if you keep interest rates low enough for long enough, then investors will finally realize that there are very few options outside the stock market to make money. You're certainly not going to make any money in a money market account or a certificate of deposit, and the returns on most bonds are barely keeping up with inflation, which brings us back to stocks. Just how low are interest rates? They're the lowest I've seen in my 34-year career.

When I say interest rates, I'm really referring to the federal funds target rate, which is commonly referred to as the "fed funds rate." The fed funds rate is currently at zero, which happens to be the lowest level ever recorded in the entire history of the United States. In case you forgot, interest rates cannot go lower than zero! Here's something to ponder: during the past 50 years, the fed funds rate has averaged 5.85%; today it's zero. That's why I love an accommodating monetary policy.

Let me move on to the fifth thing I love about our stock market: a weak dollar. Here's why. Over the next three years, I believe that the U.S. economy will struggle to grow at 2% gross domestic product (GDP). The reason is that over the next three years, housing and real estate will not recover. The only thing worse than housing in the U.S. will be employment, and if you have ugly housing, and even uglier employment, there's no way your economy can grow above 2%.

Meanwhile, the rest of the world will be growing at 5%. The reason is that over the next three years, I believe China will be growing at 10% again, as will India, Brazil, South Korea, and Singapore, to name a few. You don't need many countries growing at 10% to get the global economy to grow at 5%. Investors here in the U.S. need a bigger piece of the 5%—not the 2%—and the way to do this is with a weak dollar. This is because all of our products and services will become more competitive outside the U.S. as our weak dollar discounts everything we sell abroad. (It's that dang K-Mart Blue Light Special again.) That's why I love a weak dollar.

Sixth, I love it when all of that nervous money is sitting in cash. It seems like everywhere I go, investors are shell-shocked about our market, and are sitting in cash. Here's why this is important. We can have strong earnings, strong balance sheets, a market that's on sale, an accommodating monetary policy, and a weak dollar, but none of these fundamentals matter if there's no money to buy stocks. The catalyst for the next bull market just might be all the money sitting on the sidelines in cash that's ready for investors to use to "buy the dip."

Finally, what I love most of all is being a new "grandpap." That's right, my wife and I were just blessed with our very first grandchild, Belle Marie Neidhart. She's a beauty, if I may say so myself. GrandPap Dr. Bob has a nice ring to it, don't you think? Anyway, take a look at this photo of Belle Marie and me as I explain to her why it's so important to always "buy the dip." She's going to be a savvy investor just like her GrandPap Dr. Bob!

As always, let me bring this commentary to a close with my customary pearls-of-wisdom quote. This one's from author, Mary Waldrip: "Grandchildren are God's way of compensating us for growing old." Young and old alike should always remember to "Have a great day, keep a positive attitude, and please join me in resolving to remain a long-term investor in a short-term world."

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The views expressed here are those of Dr. Bob Froehlich. Dr. Bob Froehlich's views are not necessarily those of The Hartford and should not be construed as investment advice. They are subject to change. All economic and performance information is historical and does not indicate future results.

Dr. Bob Froehlich's sources of information include Bank of Canada, The Bank of England, Bank of Japan, Bloomberg News, Business Roundtable, China Investment Corporation, CIA. World Fact Book, CNBC, Congressional Budget Office, Deutsche Bank, The European Monetary Union, Federal Reserve Board, The Financial Times, Freddie Mac, FOX Business, Goldman Sachs, International Monetary Fund, International Strategy & Investment, Journal of Commerce, Merrill Lynch, PIERS Global Intelligence Solutions, Strategas Research, Thomson Reuters, Union Bank of Switzerland, U.S. Census Bureau, U.S. Department of Commerce, U.S. Department of Labor, U.S. State Department, U.S. Treasury Department, The Wall Street Journal, and The World Bank.

PAST ECONOMIC PERFORMANCE DOES NOT ENSURE FUTURE RESULTS.

Distributed by Hartford Securities Distribution Company, Inc.

1 The Dow Jones Industrial Average (DJIA) is an unmanaged, price-weighed index of 30 of the largest, most widely held stocks traded on the NYSE.

All information and representations herein are as of 10/11, unless otherwise noted.

P6170_101011 107726 10/11

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