{"id":425,"date":"2013-05-14T15:36:27","date_gmt":"2013-05-14T15:36:27","guid":{"rendered":"http:\/\/www.wallstreetandkstreet.com\/?p=425"},"modified":"2013-05-14T15:36:27","modified_gmt":"2013-05-14T15:36:27","slug":"liquidity-over-corporate-results-climbing-the-fts-wall-of-worry","status":"publish","type":"post","link":"https:\/\/www.wallstreetandkstreet.com\/?p=425","title":{"rendered":"Liquidity Over Corporate Results? Climbing the FT\u2019s Wall of Worry"},"content":{"rendered":"<p>The folks at the <b>Financial Times<\/b> are trying to make sense of the U.S. stock market rally, which, it is fair to say, has surprised them.\u00a0 Here is their take and my brief response:<\/p>\n<ul>\n<li>The state of the world economy is \u201cunderwhelming at best\u201d with Europe in recession, China slowing, and U.S. growth only \u201cbland.\u201d\u00a0 <b>Dr. Tom\u2019s response<\/b>:\u00a0 I agree.<\/li>\n<li>U.S. earnings growth is \u201crespectable\u201d but generated by cost-cutting, not revenue growth, and may be unsustainable.\u00a0 Companies cannot \u201ccut their way to growth\u201d forever.\u00a0 <b>Dr. Tom<\/b>:\u00a0 Profit growth is closer to \u201cweak\u201d than \u201crespectable\u201d but is not bad for this point in the business cycle.\u00a0 For the past 20 years I have been hearing that the \u201ccost-cutting story is over\u201d but it never is.\u00a0 Meanwhile U.S. GDP growth may pick up over the next few quarters.\u00a0 See below.\u00a0 (Note that Q1 revenue growth is not as bad as the aggregate figure sounds, because it is dragged down by a big drop in energy; most other sectors are up low-single-digit.)<\/li>\n<li>Companies are relevering, as Apple illustrates.\u00a0 <b>Dr. Tom:<\/b>\u00a0 Apple is a special case.\u00a0 Most large firms companies are not aggressively relevering.\u00a0 Some observers (e.g., Bill Gross) overestimate how much low rates are boosting earnings of large firms, many of whom have more cash than debt and so are actually hurt by low rates.<\/li>\n<li>Defensive stocks are outperforming, which reflects the weak macro environment.\u00a0 <b>Dr. Tom<\/b>:\u00a0 Partly true, but it also reflects their relatively high dividend yields.<\/li>\n<li>The main reason for the rally is \u201ccentral bank speak:\u201d\u00a0 \u201cCentral banks want companies to borrow, and investors to buy risky assets.\u201d\u00a0 There is a \u201cdisconnect between stocks and the world economy.\u201d\u00a0 <b>Dr. Tom<\/b>:\u00a0 The disconnect is common and normal; see below.<\/li>\n<li>A corollary of the above:\u00a0 when central banks finally raise rates, stock prices could crater.\u00a0 <strong>Dr. Tom<\/strong>:\u00a0 Not so; see below.<\/li>\n<\/ul>\n<p><b>What the FT Fails to Mention<\/b><\/p>\n<p>The alleged \u201cdisconnect\u201d between profits and stock prices is not anomalous but normal.\u00a0 Historically when profits are \u201cbetter than expected\u201d because companies have pricing power (aka \u201cinflation\u201d) the Fed tightens and stock prices fall despite strong earnings.\u00a0 The best example is the 1987 stock market crash.\u00a0 Conversely, stocks frequently perform well in periods of weak profits but ample central bank liquidity such as 1985-1986 (when profits fell but stock prices soared) or the end of recessions (1982-83, 1991, 2003).\u00a0 Currently we are in the \u201csweet spot\u201d \u2013 plenty of liquidity and underwhelming but not terrible profits.\u00a0 (As an aside, the tendency of stocks to rise in a weak economy is one of the many reasons why it is futile to time the stock market.)<\/p>\n<p>After \u201cgoing nowhere\u201d since 2000, stocks are still reasonably valued (though no longer dirt cheap) with a trailing PE of 15.2x versus a Q1 2005-Q2 2007 average of 16.2X.\u00a0 With negative \u201ctail risks\u201d becoming less likely, investors are willing to pay up for equities offering better returns than bonds.\u00a0 With the dividend payout ratio at only 32%, dividends may rise faster than profits, causing yield hungry investors to pay up for stocks. (I am hearing that bond funds are starting to buy stocks for their yields, which is a bit scary.\u00a0 High yield stocks such as utilities, staples, telcos, etc. are expensive.)<\/p>\n<p>Profits may reaccelerate modestly before the next recession.\u00a0 The Federal budget deficit is smaller than expected, so yet more fiscal austerity in the U.S. is not likely.\u00a0 Pro-growth reforms &#8212; tax reform, immigration reform, and possibly ObamaCare\u00a0 repeal &#8212; may boost confidence and growth.\u00a0 With his administration swimming in scandal, Obama won\u2019t be launching new attacks on capitalism.\u00a0 And Europe may start to grow again.\u00a0 Meanwhile, corporate America is \u201crolling its own growth\u201d via share buy-backs, judicious M&amp;A, and restrained capital spending that avoids margin-killing over-expansion.\u00a0 (Here is another why it is so hard to time the stock market: full-blown \u201cprosperity\u201d a la the late 1990s leads to overinvestment and margin collapse, as well as Fed tightening.)<\/p>\n<p><strong>\u00a0When QE Ends . . .<\/strong><\/p>\n<p>. . . stocks may well decline or flatten out for a while.\u00a0 But a true bear market is unlikely because A) the Fed will not tighten until the economy is stronger, B) stocks are seldom clobbered by widely anticipated developments. The way to think about it is that this year stocks may run up ahead of fundamentals, and then digest their gains and \u201crest\u201d for a few quarters once liquidity is withdrawn.\u00a0 Today on CNBC David Tepper makes the smart argument that, with Treasury bond issuance declining as the deficit shrinks, the Fed actually\u00a0\u201cneeds\u201d to taper\u00a0bond purchases to avoid putting the financial markets in overdrive.<\/p>\n<p>Copyright 2013 Thomas Doerflinger.\u00a0 All Rights Reserved.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>The folks at the Financial Times are trying to make sense of the U.S. stock market rally, which, it is fair to say, has surprised them.\u00a0 Here is their take and my brief response: The state of the world economy &hellip; <a href=\"https:\/\/www.wallstreetandkstreet.com\/?p=425\">Continue reading <span class=\"meta-nav\">&rarr;<\/span><\/a><\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[1],"tags":[95,112,21,8],"class_list":["post-425","post","type-post","status-publish","format-standard","hentry","category-uncategorized","tag-bull-market","tag-finiancial-times","tag-profits","tag-stock-market"],"_links":{"self":[{"href":"https:\/\/www.wallstreetandkstreet.com\/index.php?rest_route=\/wp\/v2\/posts\/425","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.wallstreetandkstreet.com\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.wallstreetandkstreet.com\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.wallstreetandkstreet.com\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.wallstreetandkstreet.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=425"}],"version-history":[{"count":2,"href":"https:\/\/www.wallstreetandkstreet.com\/index.php?rest_route=\/wp\/v2\/posts\/425\/revisions"}],"predecessor-version":[{"id":427,"href":"https:\/\/www.wallstreetandkstreet.com\/index.php?rest_route=\/wp\/v2\/posts\/425\/revisions\/427"}],"wp:attachment":[{"href":"https:\/\/www.wallstreetandkstreet.com\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=425"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.wallstreetandkstreet.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=425"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.wallstreetandkstreet.com\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=425"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}