Bell Investment Advisors - Monthly Market Analysis

After a strong showing in July, global stock markets returned some—but not all—of the previous month’s gains in August. The S&P 500 Index declined -4.5% while foreign stocks, as measured by the MSCI EAFE index, fared a bit better, falling just -3.1%.

At this point, the S&P 500 Index remains above its 2010 low, established on July 2. We continue to believe that those lows will hold and that the 16% decline in the S&P 500 from April 23 to July 2 will prove to be the extent of the correction. As a result, we view the pullback in the S&P 500 that occurred from August 9 to 26 (-7.1%) as simply a retest of the July 2 low, a common occurrence after corrections. Since 1950, there have been eleven corrections in the S&P 500 in the range of 12% to 18%, seven of which required a retest of the low before moving on to a new bull market high.

One of the key components of our view that the recent market weakness is just a correction and not the start of another bear market is the continued strength in the recovery of corporate earnings. According to Thomson Reuters, of the 490 S&P 500 companies who have reported second quarter earnings (as of August 27), 75% beat expectations, 10% were in-line with expectations, and only 15% fell short of expectations. Additionally, consensus estimates for full-year 2011 S&P 500 earnings stand at $80, just $5 short of pre-recession levels. Given that trailing-twelve-month (TTM) S&P 500 earnings were less than $8 just one year ago, it puts the robustness of this recovery into perspective.

Despite the huge surge in earnings over the past twelve months, equity valuations remain in check. As you know, we like to look at valuation measures that incorporate normalized earnings when coming out of a recession—the reason being that earnings are depressed and in recovery mode at that point in the business cycle and don’t accurately reflect the true earning power of corporate America. However, earnings have rebounded so much that we can look at non-normalized earnings measures and come to the same conclusion—that stocks are reasonably priced. The price to earnings ratio (P/E) based on TTM earnings is just 15.6, which is inline with its historical average. Given the current low level of interest rates, it looks downright attractive. Overseas, equity markets look even cheaper in most developed markets.

Despite the current level of high volatility, we continue to view equities as attractive relative to other investment assets, save high-risk bonds. As a result, we continue to accept market risk. Our strategic areas of allocation remain as follows:

• Domestic large-, mid-, and small caps	• Gold mining companies
• Value investments (relative to Growth)	• Industrial companies
• Asia ex-Japan region	• Technology companies
• Real Estate Investment Trusts (REITs)	• High-risk bonds