Six Reasons Top Wells Strategist Likes This Market

In his latest newsletter, James Paulsen, chief investment strategist for Wells Capital Management, says he believes “the economy and the financial markets have finally turned a corner and are probably ‘very early’ in a new recovery cycle,” meaning that investors shouldn’t cash out of stocks after the big recent rally.

“We caution investors against letting the horrors experienced during the last couple years overly color contemporary investment strategies lest it produces a portfolio well-positioned for the crisis now passed rather than the recovery rally just forming,” Paulsen writes. Stocks will likely remain volatile, but the overall trend should be well to the upside, he says. While Paulsen was pretty bullish throughout the worst of the crisis, he provides some interesting reasons and data points for his continued optimism:

The Market Has Bottomed, But Hasn’t Rallied Yet: “Equities may have lifted off crisis lows,” Paulsen writes, “but a new bull rally based on and driven by a sustained economic recovery has not yet even started!” The market, he says, “has been in a bottoming process for almost 10 months and finally appears to have a nice firm base from which it can soon launch a new bull rally!”

Compelling Values: While the market’s P/E ratio is in the 15 range, Paulsen — like Jeremy Grantham and several other gurus we’ve previously highlighted — says you have to take inflation into account to get a true idea of the market’s value.

“Although the current PE is only average, when adjusted for the very favorable contemporary environment of stable inflation and low interest rates, the current valuation of the stock market is cheaper than any time since the 1950s and remains in the lower quartile of valuation opportunities since 1870!” he says.

Big Profit Leverage: “During the last two years, U.S. businesses have been sizing their companies for the second coming of the Great Depression, or at the very least, for a prolonged period of sluggish economic growth,” Paulsen says. “As economic recovery brings renewed top-line growth, corporate profits may continue to amaze and outpace expectations.” His research finds that “when businesses focus on ‘rightsizing’ (by improving productivity and purging payrolls and factory capacity), about one year later, corporate profits have tended to rise.”

Dominance of Doubt: Despite all the positive signs of the past few months, “investor sentiment at best remains cautious and more likely is still bearish,” Paulsen writes.”The emotional, financial, and economic fallout from this crisis was so severe and dramatic it has left a legacy — a “dominance of doubt.” That should limit the downside potential of the market, he says, and shows that there is pent up demand for stocks that could be unleashed at some point.

Cash on the Sidelines: Paulsen says money market cash levels are very elevated. And, given the low current interest rates that those funds are earning, he estimates that much of that cash — close to $5 trillion — is on the sidelines not because of competitive returns, but because of stock fears. “Should fears continue to subside in the months ahead, considerable buying power could be reallocated toward stocks!” he says.

Stock Market Policy Push: “In the old days, it was ‘Don’t fight the Fed’!” Paulsen writes. “Today, its don’t fight the Fed, the Treasury, the president, Congress, and all developed and developing world economic policy officials! … It is not often investors get this much broad-based effort on their behalf, and portfolios should be positioned to take advantage.”

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