This week brought some good news regarding Europe and the US economy, leading to a welcome rally in the stock market. As a result, the S&P 500 is on track for its best week since March 2009.
The mood is certainly brighter now than in the previous few weeks, and we are pleased to see central banks’ action on the European debt situation and encouraging reports related to employment, retail sales, and consumer confidence. Serious issues remain, of course, and it will take some time for us to see the ultimate resolution of the sovereign debt problems in Europe and any associated fallout. While we wait, we are finding plenty of bargains in US stocks, which are trading at valuation levels (price/earnings ratios, etc.) last seen in the depths of the financial crisis of 2008-2009.
Wharton professor Jeremy Siegel recently gave an interview in which he makes the case for buying stocks now. His primary reasons for believing that stocks are “extremely attractive” include strong growth in corporate earnings and very low interest rates, which make bonds less desirable alternatives.
In response to a question about the holding period likely to be required in order to realize good returns, Siegel responds:
[F]rom these valuations and under these interest rates, you are generally going to get good returns in three to five years…Basically, stock prices depend on earnings and interest rates. That’s the fundamentals. Right now they are even more favorable toward equities than last year. Does this mean that in 12 months returns are going to be good? No. But does it mean three to five years returns are going to be good? That’s a much higher probability.
His point is simple: when you are buying stocks at low valuations, you increase the chances of achieving favorable returns. There is no way to know what is going to happen in the short term, including today amidst uncertainty regarding Europe and the global economy. The market would likely jump on any good news, particularly relating to Europe; it could drop if the situation deteriorates; or it might bounce up and down for a while as these issues continue. Buying today and patiently holding while these issues play out, however, is likely to be a winning strategy.
