As global stock indexes flirt with breaking through the highs of 2007 (and 1999 for that matter), investors appear to have mixed feelings. Many believe that the strength of recent years is unsustainable and that ultimately a significant pull back — maybe to the 2008 lows is a possibility. On the other hand, there is a more optimistic group — yours truly included — who believe that we are merely in the 3rd stage of a bull market that, with corrections along the way, will take us to much higher levels

One of our favorite stock market strategists is Laszlo Birinyi. At 69, Mr. Birinyi has advocated for decades the importance of making money by avoiding losses — a theme and spirit very much embraced by our team. One of his most interesting and timeless insights over his career has been his description of the “four phases” of a long bull market. The first he describes as reluctance. As global markets initially advance investors are reluctant to accept that it is for real. The second phase is consolidation, when market indexes trade sideways — sometimes with significant volatility. The third phase he calls grudging acceptance — a period when investors recognize that it is for real and that they are under-invested and grudgingly begin buying stock…pushing stock indexes higher. The final phase, exuberance, is a period when no one — including your friendly counseling bartender or cab driver — wants to be the last one in the pool! This phase pushes indexes ever higher and, as you can imagine, ends badly. The bear markets of 1973-74, 1982-83, 2001-02 and 2008-09 are good examples of phase 4.

Our research suggests that we are in the third phase of this bull market that began in 2009. There are several data points that support this thesis. The first is investor confidence. Though investors have recently gained some assurance evidenced by the recent strength of the market, investor confidence levels remain significantly below average — most likely due to the flow of negative news and the after effects of “the lost decade.” This highlights an additional data point that suggests that global market indexes may continue higher — money market levels. Institutional and individual investors continue to be under-invested in stocks relative to their investment policy in regards to institutions, and relative to historical norm in terms of individual investors. These higher than normal money market balances have started to be “grudgingly” invested as markets move higher. Lastly, as we have stated previously, global stock markets are historically undervalued. Though many stocks are trading at 1999 levels, most companies are 3 times bigger in terms of profits. This has created what we call a “valuation phenomena” — a situation where the price earnings ratio (or “P/E”) is historically low. The last time this valuation level was reached, global stocks continued upward for years. The most recent strength in global indexes has been rewarding for your portfolio of great quality global companies and we believe that this will continue, with corrections along the way.

As phase 3 of this global bull market continues, we will be watching closely for phase 4. Additionally we, like Laszlo Birinyi, will continue to be very aware of avoiding significant losses. Therefore, we continue to actively manage the risk of your portfolio through your portfolio’s asset allocation, sector management and the use of carefully placed stop losses — all employed to mitigate catastrophic loss.

The bond market and money market continue to offer little value to investors given the current historically low interest rate levels. Therefore, we will continue to employ a combination of our “bond alternatives” such as utility stocks, preferred shares, master limited partnerships and real estate investment trusts which we believe can provide bond-like yields with lower than stock market volatility.

We hope you find this update helpful. If you would like to get together to review your portfolio or have experienced a change in your financial circumstance, please let us know at your earliest convenience. All of us wish you a joyful spring season and appreciate our relationship with you.

Sincerely,

Your Team at Main Street Research