Forget volatility; time to invest is now

It was only last July when the Dow Jones Industrial Average surpassed 14,000.

It was only last July when the Dow Jones Industrial Average surpassed 14,000. At the time, money surged into the stock market and into private-equity investments.

Today, the reverse is true, with investors growing pessimistic by the day. Despite that view, Morningstar Investment Services Inc. of Chicago, sees today’s market as a time to buy.

Like every other investor, we take the current news very seriously. After all, a slowdown in the U.S. economy has real consequences for companies and governments across the globe.

However, we see dips as long-term opportunities more than anything else.

Investors will need to negotiate through some short-term volatility, but for investors with at least a three-year time horizon, volatility can provide some interesting prospects.

It should come as no surprise, then, that we recommend an overweight allocation to equities.

While companies will no doubt find it tough in such an environment, the sell-off of the past nine months has already factored in any likely downside company earnings.

Additionally, as the Federal Reserve’s interest rate cuts work their way through the economy, we expect to see investors responding more favorably.

Time and again, interest rate cuts have been a leading indicator of the likely direction of the stock market, and we don’t think this time will be any different.

In fact, while declining rates have led to a recent weakening in the U.S. dollar, we are willing to go out on a limb and say that the dollar is likely oversold at this point against certain currencies, especially the euro.

While it is impossible to tell when the tide will turn, the widening disparity in purchasing power between U.S. and European Union citizens is a harbinger of better days ahead for the greenback.

Among equities, we are emphasizing large-caps (both in the United States and overseas) and growth stocks. We believe that growth stocks as a group are underpriced.

In our view, some of the strongest earnings are continuing to come from growth companies, such as those in the technology sector. But investors are ignoring these fundamentals, choosing to simply sell indiscriminately in the short run.

That will change as the market calms — and it will — even if the headlines suggest otherwise. And what better investments are there than growing companies whose stocks can be purchased for value prices?

Meanwhile, with yields on high-quality taxable fixed income only sliding further after the Fed’s recent interest rate cuts, we have become even less enthusiastic about this area.

Conversely, as prices on municipals continue to drop and yields continue to rise, we have become more bullish on this category.

There is good potential for a strong total return in this area of the market, and we would recommend it to investors.

We are also taking a close look at two other areas of the bond world: high-yield and bank loans. Both have recently sold off aggressively, and there is a fear that defaults will rise and negatively affect returns, as well as a concern about a looming supply of mergers-related new issues.

We believe that this is setting the stage for what might be a nice entry point for investors into these asset classes.

While we agree that these fears aren’t entirely unfounded, we’re beginning to approach a point where there has clearly been an overreaction.

One commodity we can’t get excited about is oil, even as it is grabbing more and more headlines.

We simply think that this market is approaching speculative proportions as investors ignore data showing that there is a growing disconnect between demand and prices. This is not a sustainable trend.

So while we lack a crystal ball to tell us exactly when the volatility will ease, take comfort in factors such as valuations, which indicate that equities currently appear undervalued.

Yes, we are clearly in a downturn, but the best thing to do in today’s market is take a long-term view.

While it is tough to live with losses in the near term, now is the time to buy, not sell.

Kunal Kapoor is president and chief investment officer at Morningstar Investment Services Inc., a unit of Morningstar Inc. of Chicago.

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