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No New Normal for Nygren

In his most recent shareholder letter, Oakmark's Bill Nygren takes issue with the gloom and doom view.

Bond giant PIMCO's mantra lately has been The New Normal. By this, Bill Gross, Mohammed El-Erian, Paul McCulley, and others at the Newport Beach, Calif., juggernaut mean that the economy will eventually recover from the recent crisis, but GDP will not sprint ahead with prodigious gains anytime soon. Stability after the recovery will mean very low-single-digit growth.

It isn't just bond managers who have tepid forecasts, though. As my colleague Ryan Leggio pointed out recently, Jeremy Grantham and John Hussman think the stock market's dramatic runup has left stocks reasonably priced at this point, despite the fact that we are well off the market highs of 2007.

Contrast these subdued outlooks to Bill Nygren's most recent, optimistic shareholder letter for  Oakmark (OAKMX) and  Oakmark Select (OAKLX), published on Oakmark's Web site Friday. Nygren appears to take issue specifically with gloom-and-doom media-types, and he talks more about corporate earnings than macroeconomic indicators like GDP. Still, the dissimilarity to the opinions of other asset managers, including those of the bond behemoth on the beach, is striking.

In his letter, Nygren says that with the S&P 500 trading at about 900, and operating earnings in 2009 expected to be in the $60s, many analysts are claiming that stocks appear reasonably valued, with a mid-teens P/E ratio. Nygren doesn't argue with this simple mathematics. Instead he wonders whether the $60 range for earnings deserves to be considered a normal earnings base. If $60 is a normal base from which to estimate future single-digit earnings growth, then the market looks reasonably or fairly valued. However, Nygren argues that operating earnings were nearly $90 in 2006. Additionally, "when a recession ends, earnings recover much more rapidly than would be implied by normal earnings growth," he says.

Nygren adds that a lot of cash is still waiting on the sidelines, despite the recent market runup. Money market balances are still high by historical precedent. Eventually that cash will seek a home in stocks. Ultimately, though, Nygren relies on his fundamental argument, that stocks are cheap based on a more realistic estimate of future earnings--one that most observers are too frightened by recent problems to see.

A glance at Morningstar's Market Valuation Graph, an aggregation of the roughly 2,000 stocks under Morningstar's coverage, shows some pockets of the market supporting Nygren's thesis more than others. The basic graph shows that stocks are about 12% undervalued, according to Morningstar's fair value estimates. However, clicking the wide moat button indicates that stocks with Morningstar's coveted wide moat rating are about 23% undervalued. Additionally, a search on Morningstar's  Premium Stock Screener for wide moat stocks with low uncertainty ratings in 5-star territory comes up with 15 names, including  3M (MMM),  ExxonMobil (XOM),  Johnson & Johnson (JNJ),  Microsoft (MSFT), and  Procter & Gamble (PG).

John Coumarianos has a position in the following securities mentioned above: MMM, MSFT, JNJ. Find out about Morningstar’s editorial policies.