Happy Anniversary!
With North American equity markets up roughly 60% since the lows of March 9, 2009, there are plenty of opinions on where stocks are going and why.
As Ian McGugan wrote in Tuesday’s Financial Post, the optimists believe the U.S. economy is going through a transformation that will see it speed ahead just as fast as it did before the crisis. The pessimists, meanwhile, believe global stocks are already running on enormous amounts of government stimulus and could easily hit the skids.
“It hasn’t been a sucker’s rally,” says economist Edward Yardeni. “It started out as a relief rally following a major bear market.”
The chief investment strategist of Yardeni Research looks back to the S&P’s rally into the end of 2008 (following the collapse of AIG and Lehman), which was followed by another 25% plunge to the March 9 closing low. In all, the market lost 56.8% from peak to trough.
“The final selloff indicated widespread capitulation and revulsion with owning stocks, especially in the financials sector.,” he writes. “Banks were trading as though they were all going to be nationalized.”
But we know that didn’t happen. The banks were successful in raising lots of capital as money poured into the bond markets. Investors and depositors scrambled to get better returns than were available in the money markets after the Fed lowered the federal funds rate down to zero on December 16, 2008.
Looking forward, Mr. Yardeni stands firmly in the bullish camp. He expects the S&P 500 will be as high as 1,350 before the end of the year – another 18.5% – and provides 12 reasons to be optimistic.
Sentiment
It remains bearish for stocks, which is usually bullish.
“Most investors are convinced that ‘this will all end badly. However, the bears have yet to stage a serious correction in stock prices. Individual investors remain especially cautious on the stock market.”
Liquidity
It is more than sufficient to push stock prices higher. Retail money market funds had net outflows of US$274.3-billion during the past 52 weeks (through Feb. 22), but most of that went into bond mutual funds or savings deposits. Money market funds held by institutional accounts totaled US$2.08-trillion during the week of Feb. 22.
Corporate cash flow
Matching the previous record high during the third quarter of 2008, it rose to US$1.52-trillion in the third quarter of 2009. It surely hit a new peak during the fourth quarter and should continue to do so in 2010. Among the most aggressive buyers of equities recently have been companies buying other companies for cash.
The Fed
The U.S. central bank is likely to maintain its zero interest rate policy for an extended period, making liquid assets less compelling to hold than stocks. The “extended period” phrase has been used by the Fed for an extended period, which could extend through the end of the year.
Earnings
They should continue to rebound. While analysts tend to be too optimistic and lower their annual estimates over time as a result, during the previous cyclical upturn in profits from 2004-2006, they raised their estimates.
Valuation
With P/Es relatively low for the overall market and for many sectors and industries, valuation is compelling. The forward P/E of the S&P 500 is currently 13.5, down from a recent peak of 15.0 during September.
Profits cycle
The upturn in profits should revive employment and capital spending, just as it always has in the past. When profits are rising, companies inevitably expand their payrolls and capacity.
Productivity
It is growing rapidly and setting new highs, suggesting that real pay per worker will continue to do the same.
Global economic growth
The global boom is clearly making a comeback after the near-death experience and economic growth should continue at a solid pace.
Leading economic indicators
For the tenth straight month, the U.S. Index of Leading Economic Indicators rose in January. This suggests that the economy may be experiencing a relatively normal recovery rather than a “new normal” subpar recovery with stubbornly high unemployment.
Sovereign debt
Crises around the world should force governments toward greater fiscal discipline. It is reasonable to be concerned that the problems in Dubai and Greece could be the start of another financial contagion, but , governments are starting to recognize that there are limits to deficit-financed spending.
Gridlock
In the United States, political gridlock continues to score wins and will soon get tested again. On November 2, 2010 it should prevail, leading to major regime change in Congress. This will result in a more fiscally conservative government.