Friday, November 25, 2011

Stock Market Return Prospect Improve

The U.S. stock market has completed its worst Thanksgiving week decline since 1932, as the S & P 500 dropped 4.7%.  As a result, market sentiment measures have reversed sharply and have fallen to exceptionally depressed levels.  Consequently, return prospects for stocks have improved enough to warrant cautious buying.

For those investors with no allocation to emerging market equities, now is a reasonable time to initiate a position, with this area falling to a seven-week low.  Valuations on emerging market equities are favorable in absolute terms.  The earnings yield is 1.5 standard deviations above the 16-year average, for example.  Relative to developed markets, however, valuations are not particularly attractive.  Valuations in developed markets are attractive, especially relative to bonds.

A modest addition to emerging markets seems appropriate, with greater purchases of multinationals in the developed markets, notably the U.S.  If cash reserves are insufficient for this, I'd suggest reducing government bond holdings, as U.S. government bond valuations have become quite unattractive, both relative to inflation and relative to equities.

Steve Lehman

S & P 500:  1159
EEM:  36

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