5 Key Issues Every Investor Should Focus On

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5 Key Issues Every Investor Should Focus On
Posted: 08/20/2008
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By Ron Sweet,Vice President, Equity Investments

With so much market dislocation, it's very difficult to predict what will happen on a given day. Two or three hundred point moves in the Dow have become the norm, not the exception. But if we step away from the noise, here are five key issues that USAA is closely monitoring to get through these turbulent times.

1. The bear is still roaring.

As of July 15, we're more than 20% off the market's peak. This signifies that we are officially in a bear market. A quick look at a chart of the S&P 500 Index closing price performance shows that from Oct. 19's market peak through July 15's market low, the general trading range kept moving down, with lower highs and lower lows.
We've taken advantage of this trading range in managing the asset allocation of our portfolios by buying on significant dips and selling after strong rallies, but in terms of market health, we want to see the trading range move up significantly (higher highs for the top of the range and higher lows at the bottom of the range). We have gotten a little of that since July 15's low, but not as sharp of a recovery as we've seen in previous bull markets.
The latest rally looks a little too much like the false rally we saw in April and May. So, we are cautioning investors not to get too excited about 5% to 10% rallies. We have a lot of uncertainty to work through before we can confidently call July 15 the bottom of the bear market.

2. Valuations are attractive.

In our valuation models, we are assuming $65 in earnings for the S&P 500 Index in 2009, a level that makes current stock valuations attractive. While this is well below the cyclical high of $85 reached in 2007, it's important to remember that as recently as 1999 when the stock market was higher than its current level, earnings were below $40. We believe a normal or even weak recovery in 2009 makes $65 in earnings a conservative estimate and a compelling long-term story for stocks given current valuations.

3. We expect a weak but sufficient economic recovery in 2009.

It would be very unusual for the economy not to begin to pick up steam next year, especially with commodity prices coming down and the Fed providing so much liquidity. Recovery is highly dependent on the housing market reaching stability, and it is the weakness in housing that leads us to believe that the economic recovery will be a relatively weak one. However, we believe the stock market should do well even in a weak recovery, given current valuations.

4. At some point, the financial sector will pop.

Over the past few months, we've seen several sharp, (if short), rallies in financials, usually accompanying big positive news like January's Fed rate cuts, post-Bear Stearns Monday in March, the Treasury's backing of Fannie and Freddie in June, or better-than-expected earnings from a few key banks in July.
What these events show is that money wants to go back into financials as soon as investors can see through the credit crisis. Remember that banks have had to mark huge portions of their balance sheets down to current market prices in the middle of a credit crisis — if market prices recover on many of the beaten-down securities as we think they will, financials will soar. We do not think it's time yet to move to an overweight to financials. The risk of a financial crisis hitting a large bank this summer is still very high. A new crisis could cause another significant sell-off in financials. However, we will be watching this sector closely for a buying opportunity over the next six months.

5. Limiting the downside is critical to success.

This has been an ugly time for almost all stock markets and for many portions of the bond market, so even investors who are broadly diversified have probably experienced some losses. Certainly, diversification is still an important tool for managing downside risk. That's why in turbulent times, it is our view that you should adhere to a disciplined approach so you have the potential to capture opportunities created by market dislocations.