Be greedy when others are fearful

American equity markets continue to suffer from a disconnect, with the perception of doom and gloom overpowering a reality that is much rosier, according to Burt White, chief investment officer of LPL Financial.

Speaking at the Investment Management Consultants Association (IMCA) conference in New York, White claimed the magnitude of the disconnect is unprecedented since the creation of the modern market economy.

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“As we got out of the recession…we didn’t feel better, did we?” he asked the audience. “It’s never disconnected like this. We feel absolutely, mortifyingly awful, and yet the reality is, it ain’t Disney, but it ain’t as bad as we feel.”

He says consumer sentiment was lower at the end of 2011 than it was in the depths of the recession in 2008, when GDP was declining at an annualized rate of 8% and 600,000 jobs were vanishing per week. In contrast, late 2011 saw 120,000 jobs created per month and GDP growth was 2.5%.

“Corporations were never as profitable in the history of the planet,” he said of the volatile third quarter in 2011, and yet consumer sentiment suggested the economy was contracting at 10% per annum.

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The good news is that consumer sentiment is a rather soft statistic. Historically, sentiment tracks chain-store consumer spending rather closely, but since the end of 2009, spending has been much higher than sentiment suggests.

“One of these numbers is right, and one of them is wrong; they can’t both be right,” said White.

It would be easy to write off consumer sentiment as “soft data” and pay more heed to hard data such as sales and earnings. But this approach stymied many skilled money managers who got the fundamentals right, posted double digit losses because they misgauged the link between consumer sentiment and market returns.

“When the market tells you something, you listen,” said White.

The good news is that the disconnect between fundamentals and actual market performance has created a rare opportunity to buy companies with huge cash balances at a discount. Emotions tend to be a lagging indicator of a recovery, which explains why so many investors often miss the most profitable early stages of a bull market.

“If I told you I had an asset class that was going get you an average 9.5% return, per year, for the next 10 years, would you invest in it?” he asked. “If I told you it was stocks, would you believe me?”

Pointing to the relationship between the S&P 500’s trailing P/E ratio and the index’s future returns, he said that if these returns don’t materialize, it would be the first time the relationship had failed since the 1930s.

“I’m telling you right now, it’s time to be greedy when others are fearful. We’ve never seen this much fear, ever,” he said. “When things are scary and cheap, the long term investor is going to want to invest.”

For more of the IMCA New York Consultants Conference, read Melissa Shin’s blog of the event.