The market has been fixated on the spike in oil prices stemming from the turmoil in Libya, effectively overlooking the many positive developments on the domestic front. Granted, it is easy to be spooked by $100 oil and its impact on the emerging economic recovery.
While surging oil became the darkest cloud on the economic horizon this week, there is no shortage of other bugbears either. Europe is only just getting out of the gloomy headlines, but the overall threat of sovereign debt defaults has hardly left center stage. It is also fair to be wary of China’s efforts to handle inflationary pressures without damaging its growth prospects.
The stock market reversal in the last few days is prompting some to question the staying power of the impressive rally that started last fall. Until a few days ago, the broad stock market indices had reached new highs on the back of that rally.
Is There Room for Optimism?
I am not one to say that there are no clouds on the horizon, but I find it difficult to buy into the current level of pessimism. So yes, there is plenty of room for optimism. Here are three reasons why:
1) Unwarranted Fear Premium in Oil Prices: Notwithstanding the violent struggle in Libya, the fear in the market centers on Saudi Arabia, the world’s largest oil producer and leader of OPEC. The Saudi regime has its vulnerabilities, but none that threaten its existence.
Despite its totalitarian nature, the House of Saud enjoys a level of domestic legitimacy and authenticity that many others in the Middle East lack. More importantly, they are adept at placating disaffected domestic groups by sprinkling their enormous wealth around. The recent announcement of roughly $35 billion in new spending is essentially along those lines.
Having covered the oil beat for a while, I am of the view that the current fear premium in oil prices is reflecting a worse-than-likely scenario. And I expect it to ease in the coming days as the Libyan story settles down.
2) Economic Growth on Solid Footing: Before the current oil-centric fears, the outlook for the U.S. economic recovery had brightened significantly. The last quarterly GDP report, despite the negative revision this week, showed the beginning of a self-sustaining growth momentum for the first time in this recovery. And reports since then show a continuation of the momentum in the current quarter and beyond.
The ISM Indices are comfortably in expansionary territory, the Philly Fed Index is at a seven-year high and consumer confidence is at its highest level in three years. Even the laggard labor market is showing signs of a turnaround, with the weekly jobless claims dipping below the 400,000 mark this week. And the corporate profitability picture has been quite solid in this recovery, highlighted once again by the fourth-quarter reporting season.
The spike in oil prices, if sustained over an extended period of time, will no doubt weigh on this emerging recovery picture. But the current oil price move is no more than a temporary reaction to fears of supply disruption. It lacks staying power. More importantly, the economic recovery has enough underlying momentum to withstand $100 oil.
3) Interest Rates Remain Very Supportive: Oil spikes have a way of creating inflationary pressures in the economy. The U.S. went through that cycle in the 70s following the oil embargo. In response, central banks are forced to tighten monetary policy to bring down inflation. While some countries are faced with that challenge at present (most notably China and the U.K.), we have no such issues.
In fact, the U.S. just beat back concerns about deflation with the help of the Fed’s QE2 program. Even as the QE2 program comes to an end later this summer, monetary policy will remain supportive and stimulative. The eventual tightening cycle is expected to be at least a year away, if not more.
And despite much talk about U.S. fiscal imbalances, long-term interest rates remain quite low by historical standards at under 3.5%. If anything, flight-to-quality trades resulting from the Middle Eastern unrest are pushing treasury yields further down. This helps companies and consumers cost-effectively meet their funding needs.
Making It All Work For You
The herd mentality of investors is well documented. Everyone piles into the momentum trade when all is hunky-dory, but run for the hills at the first sign of trouble. While that is a bad investment style at any time (if that can be called a ‘style’ at all), it is particularly unsuited for these turbulent times.
You don’t need to be a professional to make money in this market. But make sure you understand that consistently picking winning stocks requires a disciplined due diligence process. While such winners have many attributes, three really stand out – Earnings Growth, Quality, and Valuation.
- Earnings Growth: The most important attribute of a winning stock is its earnings growth profile. But what makes the stock soar is not just plain vanilla earnings growth, but the company’s ability to produce positive earnings surprises. The Zacks Rank helps you capture this key growth attribute. At any given time, stocks with a Zacks #1 Rank (‘strong buy’) offer the best earnings growth profiles of the entire market.
- Quality: Quality has its subjective components, but I am referring to the quality of the company’s products/services, financial health and management. You want to invest in a company that enjoys a competitive advantage in its product/service market, is in strong financial health and is led by a proven management team. There is nothing subjective about any of these attributes.
- Valuation: If all the positives about a company are already out there in the market, then you may have already missed the bus. How can you tell if that is the case? Looking at the company’s valuation multiples, such as price-to-earnings (P/E) or price-to-book (P/B), and comparing those to its peers should give you a good idea of relative valuation. Buying a quality stock at a discount to its peers is your best bet for generating an above-average return.
The best way to analyze, choose and track such winning stocks in any market is by using the tools and resources available in Zacks Premium. You can try Zacks Premium, and receive unlimited access to our exclusive Zacks Rank, for 30 days free.
Sheraz Mian
Sheraz Mian is the Director of Research at Zacks Investment Research where he relies on access to valuable data to assess winning stocks and funds. Now, you can access the same data free for 30 days just by trying Zacks Premium.
