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Looking Past the Present

By Bob Landaas                        

Long-term investors should correctly focus past the immediate problems in Europe and the upcoming U.S. elections. If they do, they will realize a U.S. stock market that is undervalued relative to record profits.

The fundamentals of the stock market require you to focus on interest rates and earnings.

Earnings are expected to hit a record level again this year, which isn’t suggesting the Dow is going to 14,000 anytime soon, but we should see a fairly strong market as the macro events in Europe weigh less on the financial markets.

The other driver of stock prices is interest rates, which are at record lows. The yield on the 10-year Treasury is below 1.5%. And the Federal Reserve has made it quite clear that it has no intention of raising short-term interest rates until the end of 2014 – at the earliest. It’s unusual that investors get a two-year window knowing that interest rates will remain fairly steady for some time to come.

Investing in the stock market requires people to focus on the fundamentals. Occasionally, like this past spring, markets will hone in on macro events such as what is going on in Europe. But it’s rare that macro events guide financial markets for more than just a short time.

The situation in Europe is two-fold. First, the European Central Bank is looking for the authority to regulate the domestic banks of the 17 member nations. That will take some time because many nations are reluctant to give up their sovereign rights.

The second part is the euro zone guaranteeing the sovereign debt of every member nation. More affluent members such as France and Germany are more reluctant to agree to that type of loan guarantee, but it’s necessary to bring the euro zone through its crisis.

The European debt crisis is, in my opinion, a solvable problem. What we’re experiencing is the pushing and shoving over who’s going to pay for it all. But it is a solvable crisis and one that I feel will be brought to a conclusion in the fairly near future.

We often get questions on what is now being called “Taxmageddon.” That is referring to the expiration of the Bush tax cuts and the mandate of 4% spending reduction by the federal government unless Congress agrees to other arrangements.

Americans’ approval rating of Congress continues to be at an all-time low. I suspect that’s because of a belief of Congress’s inability to legislate and inability to compromise for the good of the country.

Hopefully, we’ll see a compromise this fall or early winter that provide slight tax increases and modest reductions in spending to lower the deficit while still allowing for continued economic growth.

I strongly encourage investors to remember that it’s not politicians that move markets, but it’s earnings. Keep your eye on earnings.

When I share with clients the fact that profits are the highest they’ve ever been, they normally respond with, “No kidding.” When I tell clients that the U.S. economy is the largest it’s ever been, I get a similar response.

The American consumer appears to be awakening from a long slumber as car sales and housing continue to improve. I am encouraged by the decline in oil prices. It’s certainly good news for the American consumer. Every penny per gallon reduction in gasoline prices puts an additional $1 billion in the pockets of American consumers.

The gross domestic product for the second quarter of 2012 came in at under 2% for the first time in over a year. But growth is reaccelerating now.

Most economists predict stronger growth later this summer and into the fall, perhaps not strong enough to reduce the 8.2% unemployment rate, but growth nevertheless.

The deleveraging process that started in the beginning of the financial crisis created a headwind for the global economy. We are perhaps two-thirds of the way through this painful restructuring. As we continue down the road of paying off debt, we will eventually get to the point at which the global economy is much less encumbered by the burden of that debt.

Short-term investors are inclined to focus on short-term volatility and current events. Successful long-term investors are right to focus on the fundamentals of interest and earnings. On that score, the future looks fairly bright.

Bob Landaas is president of Landaas & Company.

initially posted July 26, 2012

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