Focusing just on U.S. domestic data isn't enough in an era of globalization. Tom Sowanick is CIO of Clearbrook Research, part of Clearbrook Financial, a Princeton, N.J.-based third-party investment platform provider.

For the past two weeks I have been perched in Colorado watching the markets seemingly unravel on the heels of the sub-prime debacle. I was struck at how volatility had risen for both stocks and bonds. Investors were fixated on what was happening behind the closed doors of the credit markets and decided that liquidity had been turned off and the credit cycle was undergoing a fundamental change. It will take some time to see if these severe conclusions are warranted.

Clearly, conditions have changed. Credit is no longer close to free, spreads have widened to reflect risk and investors are once again kicking the tires and looking under the hood before investing. However, by focusing on the negatives investors have missed the fact that corporate earnings have returned to their previous double digit gains, up 11.1% in the second quarter (with approximately 80% of the S&P 500 companies reporting). This is not bad for an economy that is growing at a 3.4% clip.

Over there

I don't want to be Pollyanna-ish and ignore the fact that credit standards are tightening. After all, we have been arguing for quite some time that investors were not being paid to lend via the bond market. Spreads were very tight, interest rates were extremely low and the yield curve was too flat. Now that the bond market is undergoing the normalization process, investors are simply recognizing that they had it good over the past few years and now will have to pay a price to stay at the party.

Our 2007 capital market assumptions called for stocks to return 10%, bonds 3%, cash 5% and alternatives 10%. We also believed that market volatility would rise. From the Rockies I decided to review these assumptions in a cleaner air environment without the noise of CNBC chatter. The core thought behind the assumptions was that the yield curve had to grow steeper with long-term rates moving higher. If correct, that would lead to wider spreads and a re-pricing of risk across all asset classes.

Stocks were cheaper than bonds at that time and they remain so today. Hence, stocks offer a better risk/return profile. Earnings are quite strong, guidance is solid and PE multiples are lower today than at the start of the year. What is interesting about the earning's cycle is that very few investors believe that corporate earnings can be sustained. Arguments that a yield curve inversion leads to an earning recessions or earnings are up because of stock buybacks hold very little weight. The plain truth is that corporate earnings are growing because US companies have expanded their reach beyond the US. Investors need to pay more attention to the source of earnings and not rely exclusively on domestic data and inferences.

So we remain comfortable with our capital market assumptions and believe that long-term views are more important than daily market gyrations. -FWR

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