Stocks are behaving as I expected.\u00a0 On Jan 18 I highlighted \u201cvaluation levitation,\u201d writing \u201cthe market senses that, with rates so low and dividends set to keep growing, investors could decide that stocks deserve a materially higher valuation despite slow economic growth, recession in Europe, Barack Obama in the White House, etc.\u201d\u00a0 On March 6 I noted, \u201cWe may well exceed the current year-end targets of bullish strategists, of around 1600.\u201d\u00a0 Since then four or five strategists have raised their targets. When the bears finally capitulate and raise targets, it may be time to take some profits.<\/p>\n
Inexpensive versus 2004-2006, When Rates Were Much Higher<\/b><\/p>\n
I keep hearing pundits gravely declaim that we are in a\u00a0\u201cstock market bubble\u201d engineered by the Fed.\u00a0 They are dead wrong.\u00a0 Stock prices are up a lot, but so are profits.\u00a0 Since the end of Q1 2009, stock prices are up 94% but profits are up 88%.\u00a0 Valuations are very reasonable and still lower, by 1 or 2 PE points<\/b>, than their 2004-2006 average:<\/p>\n The average 10-year Treasury bond yield, 2004-2006, was 4.5%, or over twice current levels.\u00a0 So investors are not<\/b> valuing stocks as though yields will stay at 2%, which means that when yields rise there is no reason for stock prices to fall.<\/p>\n Plus ca change, plus c\u2019est la meme \u201cjobless recovery\u201d<\/b><\/p>\n The misperception that we\u2019re in a stock market bubble is understandable because: A) Bernanke has cut short rates to zero and is aggressively buying bonds,\u00a0 B) Stocks are doing well while the U.S. economy has 7.7 % unemployment.\u00a0 This situation seems weird but is actually normal.\u00a0 Back in 2009 we correctly predicted that we were likely to have yet another weak \u201cjobless recovery\u201d made worse by Obama\u2019s regulatory onslaught, but stock prices would rise nonetheless, with everyone wondering why profits and stocks were rising when the economy was weak.\u00a0 So it has come to pass.<\/p>\n We are in a replay of the \u201cjobless recoveries\u201d that followed the 1991 and 2001 recessions, when unemployment was distressingly high for extended periods, the Fed drove short rates to surprisingly low levels, but profits recovered and stock prices soared.\u00a0 Economists should do more research on why, starting with the 1991 recession, employment has been so slow to recover.\u00a0 One factor is globalization; during recessions companies cut costs by shifting operations overseas, so when demand recovers it is met with production in China and Mexico, not Ohio and Illinois.<\/p>\n Profit Scorecard\u2014Bottom-up versus Top-down<\/b><\/p>\n You need a scorecard to follow Wall Street\u2019s take on profits.\u00a0 The Street has two estimates of S&P 500 EPS —\u00a0 the \u201cbottom-up\u201d estimate reflecting analysts\u2019 estimates for 500 individual firms, and the \u201ctop-down\u201d estimate of strategists, which is based on macro variables.\u00a0 It is widely assumed on the Street that analysts are too bullish and, as the year progresses, will cut their estimates toward the strategists\u2019 top-down figure.\u00a0 Because it is generally assumed the bottom-up number is too high, it is not<\/b> bearish if it gradually declines.\u00a0 Currently the U.S. economy is doing better than expected, and the bottom-up estimate is trending lower from $115 six months ago to below $112. Meanwhile strategists are raising <\/b>their numbers modestly, to $108-110, implying profit growth this year of around 5%.\u00a0 If we hit that figure and profits look set to grow again in 2014, it will be positive for stocks.<\/p>\n Positive Message from the Early Reporters<\/b><\/p>\n A few years ago we started to analyze results of companies that report earnings in the third month of the quarter; these \u201cearly reporters\u201d provide clues as to how good or bad the upcoming earnings season will be.\u00a0 Now several Wall Street firms monitor early reporters.\u00a0 (Thanks for the imitation; I\u2019m flattered.) \u00a0What the early reporters reveal now is that Q1 earnings reported in April will be fine but not super-strong.\u00a0 Fifteen major firms reporting over the last couple of weeks divide into three groups:<\/p>\n These results and decent U.S. macro data suggest that first quarter profits, and guidance for the second quarter, will be reasonably good.\u00a0 But with the dollar strengthening and Europe\u2019s recession hurting multinationals, results will be only good, not great.<\/p>\n Not Straight Up; Beware Euro-pain<\/b><\/p>\n I have no opinion on near-term stock prices.\u00a0 Consult your local astrologer.\u00a0 But after a big move up investors have big profits to protect, so a 5% dip could occur at any time.\u00a0 As I have warned in the past,\u00a0\u00a0the most likely trigger is Europe, where\u00a0we see an ever wider and more dangerous chasm \u2013 between jobless voters in Portugal, Spain, Italy, Greece and now Cyprus (can France be far behind?) and a bumbling, disjointed, fragmented elite in Brussels and Berlin that is focused on austerity and political integration, not economic growth.<\/p>\n Copyright 2013 Thomas Doerflinger.\u00a0 All Rights Reserved.<\/p>\n","protected":false},"excerpt":{"rendered":" Stocks are behaving as I expected.\u00a0 On Jan 18 I highlighted \u201cvaluation levitation,\u201d writing \u201cthe market senses that, with rates so low and dividends set to keep growing, investors could decide that stocks deserve a materially higher valuation despite slow … Continue reading \n
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