While some investors are predicting an imminent and sustained market downturn, Jay Feeney, chief investment officer at Robeco Investment Management, still sees plenty of upside for stocks.
Mr. Feeney, who oversees $10 billion of the firm's $14 billion under management, argues that the economic environment continues to be good for stocks — despite a gain of more than 60% by the S&P 500 since its March lows.
Specifically, he believes that as investors start to feel more comfortable about the economy, they will take on more of the risk associated with equity investing, which will further fuel the market's performance.
“Valuation is the single most important factor driving stock returns, but investors can get caught up in everything else,” he said. “On balance, most investors still remain wary of the stock market, but I find it hard to believe that the market is overvalued at this level.”
According to Mr. Feeney, the equity risk premium, which is the rate of return that investors demand over U.S. Treasuries, has narrowed to about 6%, from 8.5% in March.
But the current equity risk premium is still well above the 130-year average of 3.5%, suggesting significant stock market upside potential.
“We know that the markets tend to always move in a direction that inflicts the most pain on the largest number of people,” he said.
According to Mr. Feeney's calculations, even if investor sentiment for stocks increases enough to drive the equity risk premium down a single percentage point, the fair multiple for 2010 estimated earnings in the S&P 500 would expand to 17.3, from its current level of around 14.5. That would reflect a 20% gain for the index over current levels.
Mr. Feeney explained that as a bottom-up stock picker, he is not predicting a 20% stock market rally from today's levels, but he is suggesting that even a slight increase in investor sentiment toward stocks will be enough to extend the rally.
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