Is Perception Reality

By examining the companies that make up the S&P 500, there is an interesting alternative to the perceived reality that the financial media seems to want us to believe.

We all known someone whom, on the outside, seemed to be the healthiest person we knew. They looked good, dressed well, and kept in shape…but had a heart attack at age 50. Or how about the outdoorsman that ventures out to our lakes for a session of ice fishing or snowmobiling. The weather has been below zero for some time and the lakes appear to be frozen … and yet they fall through the ice. Our perception of what is happening may be far from what is actually going on beneath the surface.  In other words, is perception reality? And when it comes to the economy and business, the financial media continues to tell us how bad it is; Greece debt Issues (again), slow growth, high unemployment, and government spending … just to name a few. So, I will ask again: Is perception reality?

By examining the companies that make up the S&P 500, there is an interesting alternative to the perceived reality that the financial media seems to want us to believe (or at least scare us enough to read or watch the news de jour). Let me provide a few examples that may surprise you. The underlying businesses have continued to show an incredible resilience in the recovery of “The Great Recession” in respect to earnings, cash flow, dividends, and the strength of their balance sheets. They are close to an all time peak in profits, with low debt level on their balance sheet. The corporate buybacks of company stock has continued to rise, and insider purchases are increasing. Simply put, the businesses that make up the S&P 500 have fundamentals that do not reflect the perception of the media.

So the next logical question is: Has this type of disconnect between intrinsic value and the underlying stock prices of those same companies ever happened before as we have seen in the last decade? If so, what were the results? Below, Davis Advisors has provided a chart that reflects the following; since 1928 the U.S stock market has experienced 12 decades of sub par returns, which they define as 5 percent per annum or less. However, in every subsequent decade the market generated what they view as satisfactory to very strong returns. 

What we are looking at is that the long-term prices of stocks have continued to track the underlying value of the business. Sometimes it may take longer to become reality, both on the upside and the downside (remember the dot com bubble). And if history is any guide (which is the only guide we have), we may be in for an impressive move forward based on the level of disconnect we have witnessed thus far. Now this is by no means a market timing call as I have enough respect for the irrationality of the day-to-day movements of the markets. I have no idea when the movement will begin on the upside or the downside for that matter … nor does anyone else. But I do know this, when investor fear and pessimism moves to a level that drives them to own a 10-year treasury that will not even keep up with the cost of living, and gold has become the “in vogue” investment to own … reality may be closer than we think.

This article was written by Lou Melone, Managing Partner, with Budd, Melone & Company in Auburn Hills, MI.