Dear Clients and Friends of Insight,
The investing landscape continues to shift as the global economy is pressured from the impact of higher and unpredictable oil prices. Uncertainty and business risks have risen, and stock prices have declined sharply from their lofty levels to start the year. By example, at its low point a few weeks ago, the S&P 500 Index had declined 9% for the year – near correction territory. Meanwhile, the growth-heavy NASDAQ Index had dropped 13% – an official correction. Beneath the surface, the damage was much greater. The average stock in the S&P 500 Index declined 18%, while the average stock in the NASDAQ Index crashed 33%!
Most recently, stock indexes have rebounded somewhat from these lows, but how the economy is ultimately affected and how investors continue to react to these uncertainties is still to be determined. We maintain the positive view we have for Insight’s recommended stock holdings, and we are comfortable with our current positioning. This belief comes from our assessment of the three most important determinants of stock prices, and hence long-term investor success. They are Business Fundamentals, Stock Valuations, and Investor Sentiment.
Each of these, in its own way, will influence the long-term success of an investment.
Let us look into each of them, starting with the most important determinant. Business Fundamentals are such things as consumption, investment, employment, interest rates, inflation, profitability, and credit quality, to name a few. Though the immediate outlook for fundamentals has become blurrier than usual, there remains tremendous strength across most sectors of our economy. We believe these businesses remain well positioned to deliver positive sales and profit growth in the years ahead – a solid foundation for higher stock prices.
The next most important determinant is Stock Valuations. They measure how much investors are willing to pay for a company’s expected future revenues and profits. Valuations tend to be higher for those companies that grow faster and have consistent profits, than for those companies that grow slower and have variable profits.
Though stock indexes are trading for historically high valuations, many companies within the indexes trade at reasonable values compared to their likely revenue and profit results over our longer-term investment horizon. This is especially important when we consider how our future economic growth is being powered increasingly by advancements in intellectual property.
Lastly is Investor Sentiment which, when it turns negative, usually has an immediate and dramatic impact on stock prices. Not only because it suppresses economic activity and challenges business fundamentals, but because it dampens the enthusiasm for future growth and prosperity. Thus, it also compresses stock valuations.
Fortunately, big swings in investor sentiment are usually short-lived and have a much smaller and declining impact over time on an investment’s success.
We are pleased to report that Insight’s recommended stock portfolio remains positive for the year! We believe this is due to how we evaluate and interpret these three basic but most important determinants to investor success. We look forward to our continuing discussions with you throughout the year.
