Stocks Are 25% Undervalued For Those Who Can Wait

Jeff Macke

As the market struggles to come off the morning lows, Rod Smyth, Chief Investment Strategist at Riverfront Investment Group is not losing sight of the fact that US stocks are cheap, specifically "25% cheap to their long-term values." The emphasis there is on long-term. Even a relative optimist like Smyth believes the markets could face a bumpy ride as investors come to terms with the new economic reality.

Smyth thinks Europe is going into recession and the US is entering a period of stagnant growth, regardless of how we label it. But he notes that if earnings come in as analysts expect, we've got $100 of earnings in the S&P500, making stocks cheap at 1,100, 1,150 or even 1,200 on the S&P. The rub is that the estimates are likely too high.

"It's all about earnings," Smyth says. "I think we're going to have a couple of earnings seasons where analysts forecasts are going to be disappointing." Recessions bring with them weak earnings, after all the accounting and productivity dust settles.

Rest easy, bulls, there will come a point at which earnings guide-downs are priced into the markets. We're just not there yet. Smyth is in the popular camp where long-term investors are holding cash and picking away at Blue Chips as markets drift lower. "In many of the great companies you're getting dividends higher than you can get in cash or US Treasuries," he says, echoing the mantra of the long-term investor.

Smyth also suggests taking a shot at what were once called Emerging Market nations. He specifically mentions Brazil which, as noted last week, seems to have a somewhat "flexible" stance towards interest rates. I gently suggested that Brazil's lack of rate stability could signal economic unrest.  But Smyth wouldn't have it, and particularly objected to my use of the label "Banana Republic."

Smyth says America should be so lucky as to have Brazil's problems. "I'd trade our fiscal situation and our outlook for Brazil's everyday of the week," he says, citing the fact that Brazil's central bank is attempting to strike a balance between growth and inflation while the US seems to have neither. He's a buyer of US-based multi-nationals and Brazilian stocks directly.

With the birth of September we're exactly one month away from the start of 3rd quarter earnings season. At that point the reduction of earnings estimates Smyth alludes to should begin to get baked into the cake. When those estimates come down, and presumably take the S&P with it, Smyth will start deploying his 20% cash-load in earnest. Until then he's hanging out in blue chips and collecting dividends.

As always, your comments and observations are welcomed in the space below.

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