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Domestic Market Commentary
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There is a lot of speculation lately about a possible economic recession. Over more than 20 years of investment experience, we have three observations regarding recessions, whether they be actual or probable:
- First, those forecasting a recession can be wrong.
- Second, investors overreact, which typically means stock prices fall below our estimate of their intrinsic value.
- Third, in our experience, rallies often follow these overreaction sell-offs and tend to begin six to nine months before the economy hits bottom.
Regarding our first observation, sometimes recessions that seem obvious never actually occur. For example, in August 1998, the case for a recession was very compelling, so convincing in fact that the market dropped 20% from mid-July through mid-October that year. The Federal Reserve eased monetary policy, and there was no recession. In mid-2006, the market dipped as the case for a recession was again adopted by many investors, but their prediction was wrong. Through the end of 2007, a year and a half later, there was no recession.
Even if there is a recession, our second observation is that investors normally tend to overestimate its potential financial impact. In a recession, some companies post disappointing earnings, even losses. That can affect value, but not as much as investors might think.
In the ICON valuation equation, we use many years of earnings to calculate the intrinsic value of companies. In our estimation, bad earnings in any one year do not have a huge affect on intrinsic value. Last month, as investors became convinced that the sub-prime mortgage problems would cause a recession, they envisioned bad corporate earnings for 2008 and sold stocks. In our opinion, this was a typical pre-recession sell-off when prices reacted more than any likely drop in intrinsic value. As these sell-offs are emotionally driven, we have not been able to quantify them nor predict their depth or duration.
As for our third observation, because these potential-recession dips can take prices far below intrinsic value, our experience shows these declines have often set the stage for a rally as prices try to catch up to intrinsic value.
We believe investors may miss these rallies because the advances typically follow the well-documented relationship of stock prices leading the economy (and news) by six to nine months. Stock prices rally while the economy (and news) continues to deteriorate. Under this assumption, if investors expected a recession to occur in 2008 and for the economy to hit bottom in September or October, it would be normal for a rally to begin from these discounted price levels in the coming weeks.
Over the last 20 years, ICON has tolerated the unpredictable, emotionally-driven sell-offs that often precede recessions so that we can fully participate in any subsequent rallies. Through our research, we do not think it is possible to “time” these dips. As we see U.S. stock prices on average to be about 33% below our estimate of intrinsic value as of January 31, 2008, we have determined that it is prudent to ride through the volatility in order to be positioned to participate in the rally our experience suggests we might anticipate.
The second half of 2007 featured an industry theme change. The leadership shifted to industries often referred to as “recession-proof,” those that are not cyclical. These industries are in sectors such as Healthcare, Consumer Staples, and Utilities.
Our system is now getting a variety of indications that there may be a new theme for the next market move. We had hoped this shift could happen without the sell-off that occurred in January 2008, but that was not the case. During that decline, industries in the Financial and Consumer Discretionary sectors performed the worst. Our system leads us to believe these sectors may emerge as part of the leadership on the rebound. In late January, we made a shift toward these potential new leaders. If our readings continue to be supportive, we may increase those positions even more.
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Bond Market Commentary
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As the Federal Reserve has eased monetary policy, short-term interest rates have dropped. This has led to a steeper yield curve, which, from an ICON valuation perspective, makes long-term bonds more attractive.
As value and relative strength readings have improved to meet our standards, we have gradually moved toward long-term bonds. Those same metrics are making higher grade corporate bonds eligible for purchase.
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International Market Commentary
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| Economic concerns are not unique to the U.S economy and stock market. International markets, in general, are behaving in sync with the U.S. market, also driven by recession worries. Just like in the U.S., recession-proof, non-cyclical stocks led in late 2007 and then most international markets experienced a sharp sell-off in January. Similar to our domestic market, we believe Financial and Consumer Discretionary issues overseas represent outstanding value and have shown strength when the market bounces higher. We expect them to be part of the leadership when the market recovers.
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Summary
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Our research shows that news is good at market peaks and bad at market bottoms. If true, this would support our belief that news-driven investors risk buying at peaks and selling at bottoms. Our valuation system was developed in an effort to overcome the emotions associated with news-driven investing.
ICON’s readings suggest valuation and other conditions typical of market bottoms. We believe it is best to remain invested, and we expect a rally to begin six to nine months before there is any improvement in the news.
Prepared by ICON's Investment Committee.
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Past performance does not guarantee future results.
Investment return and principal value will fluctuate and shares, when redeemed, may be worth more or less than their original cost.
Opinions and forecasts regarding sectors, industries, companies, countries and/or themes, and portfolio composition and holdings, are all subject to change at any time, based on market and other conditions, and should not be construed as a recommendation of any specific security, industry, or sector.
Investing in securities involves inherent risks, including the risk that you can lose the value of your investment.
An investment concentrated in sectors and industries may involve greater risk and volatility than a more diversified investment.
Investments in international securities may entail unique risks, including political, market, regulatory and currency risks. Financial statements of foreign companies are governed by different accounting, auditing, and financial standards than U.S. companies and may be less transparent and uniform than in the United States. Many corporate governance standards, which help ensure the integrity of public information in the United States, do not exist in foreign countries. In general, there is less governmental supervision of foreign stock exchanges and securities brokers and issuers.
There are risks associated with Small and Mid Cap investing such as less liquidity, limited product lines, and small market share.
Investing in fixed income securities such as bonds involves interest rate risk. When interest rates rise, the value of fixed income securities generally decreases. High-yield bonds involve a greater risk of default and price volatility than U.S. Government and other higher-quality bonds.
ICON’s value-to-price ratio is a ratio of the intrinsic value, as calculated using ICON’s proprietary valuation methodology, of a broad range of domestic and international securities within ICON’s system as compared to the current market price of those securities. To analyze intrinsic value, the ICON valuation methodology relies on the integrity of publicly released financial statements.
According to ICON, value investing is an analytical, quantitative approach to investing that employs various factors, including projected earnings growth estimates, in an effort to determine whether securities are over- or underpriced relative to ICON’s estimates of their intrinsic value. ICON’s value approach involves forward-looking statements and assumptions based on judgments and projections that are not guarantees of future results. Value investing involves risks and uncertainties and does not guarantee better performance or lower costs than other investment methodologies.
If you would like to receive, at no charge, the most recent copy of ICON’s disclosure document, Form ADV Part II, please send your request in writing to: Attention: Compliance, ICON AdvisersSM, 5299 DTC Boulevard, 12th Floor, Greenwood Village, CO 80111.
If your financial situation or investment objectives have changed, please notify your financial professional or ICON immediately.
© 2008 ICON AdvisersSM All Rights Reserved.
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