These days we hear every conceivable argument about why the bull market will die, or stop, or correct, and by how much, how fast, etc. Among the many triggers discussed, there are EU elections, job creation angst, social media bubbles, fiscal cliffs, solar flares, lunar cycles, lycanthropy (after all, we have seen a record number of investors morphing into bears since '08), and yes, the specter of the all-powerful price at the pump.
In all seriousness, I've talked about the negativity bubble a number of times since my early days writing for Minyanville, and in my view it's still thriving.
What we don't really hear, or hear a lot less of, is what will keep the bull running. Hosts of experts will talk endlessly about earnings growth (yes, guilty as charged, I use that myself), but I don't see a lot of clear, cohesive work on the macro factors that will drive companies to need to produce, expand, grow, and compete. I also don't see market pundits blending those factors into a matrix that compares all the choices in the investment landscape. I do this every day, so let me share some key variable/themes and how they interplay. When (not if) the bull continues, you'll have this partial list of key reasons:
1. Competitive Innovation
To me this is the ultimate driver of wealth creation and the biggest factor in determining long-term growth of corporate cash flows. What have companies like Caterpillar
(IBM), Google (GOOG)
, McDonald's (MCD)
, and Coca-Cola
(KO) done in the last five, 10 and 30 years or more? They've assessed, invented, developed, produced, and ultimately competed.
2. US GDP
Last year, I called for a GDP re-acceleration (Q4
delivered 2.8% and Q1 at 2.5%) while ECRI
was calling for another recession. Also, early and through the first half of Q1, most economists were in the 1.3-2.0% range. As the quarter progressed, estimates progressively edged higher. While the economy will likely remain lumpy, we are nowhere near those double dip fears common during mid-last year's EU scare fest. Another theme of mine, the "jobs tsunami thesis," has also been bumpy since early 2011, but it's still working better than the clarion calls for near-zero job growth. Further, the PMI, LEI, ISM and Regional Fed surveys increase the odds that economic activity in future quarters will stay in a 2-3% range than the zero line or below.
3. Very Low Rates
Simply put, the current Fed and global central banks are holding interest rates at levels well below what would normally be considered highly stimulative. Rates could rise 200 bps, and still be at levels where prior Fed
easing cycles have stopped at the lows. In my view, this is vastly under-appreciated. Moreover, very little credence is given to the duration of these low rates. This duration effect produces a compounding factor for future stimulus.
4. Realignment of Consumer Savings Vs. Debt Load
I believe one of the most significant long-term benefits of the real estate bubble popping could be the significant rise in the savings rate. If this holds, the future consumer will continue to shift from spending irrationally to saving rationally. This will pay huge dividends for long-term future consumption as it amplifies the future wealth effect.
5. Europe Is in a Recession, So What?
OK, so the EU (or most of it) is in a recession. The key question is, how severe is this recession? And how much does it impact the US? However, the net effect of the EU economy on US GDP looks to be materially overstated by many. First there's the simple fact that economic activity in the EU region is already at a lower base. Second, the effect or impact of Europe's problems on the US GDP is often overstated. A recession in the EU of negative 2.5% would reduce the US GDP "measure" by 0.1%. For example, US GDP of 3.0% would drop to 2.9%. An even steeper decline of 5% in economic activity (which would be massive off the current base) would drop the rate to roughly 2.8%.
(It's worth noting that at a 7% growth rate, China creates the GDP equivalent of Greece (annual output) in 11 weeks.)
At the end of the day, the raw impact of an EU recession is minor. The only significant factor to consider is whether another dramatic shock in the EU will set off another global banking contagion. While we can't say this is ever off the table, I think two factors reduce a contagion likelihood. The first would be the aging of the bad debts and losses already taken since 2008; the second is the LTRO
(or Long Term Refinancing Operation) and its ability to help EU area banks increase earnings, thus allowing for more retirements of bad debt.
6. Valuation Expansion
US markets are poised for meaningful valuation expansion. This will be magnified in the growth stock universe, where valuations have essentially dropped to traditional value stock comparables
. For some more quick math, if US earnings (on SPX
) are $105 and stocks trade at a multi-decade average (50 years) P/E of 14, the value of the index would be 1470. Now let's say the growth stocks trade at a more traditional but low PE of, say, 18 (well below the growth that many companies are producing), and the value stocks remain at 14 times. In that case, the index PE would rise to 16. Sixteen times $105 equals 1680. Bottom line, we haven't entered the bottom of this range yet. And I don't think it will stop at the 1470 level.
7. Competition for Investment Dollars
Let's look at today's landscape. Fed funds rate near zero, thus money markets pay nothing. Ten-year Treasuries at and below 2%. Solid corporations
at 3%. The bull has been running with the ancient metal of kings on his back for between 10-15 years. That high price of gold has to be weighing on him. We can't all buy farmland. We can't all buy five to 10 houses, or more, and turn them into rental properties. We can't all own and maintain apartment complexes. And none of those higher dollar (and maintenance) alternatives offer day-to-day liquidity. Therefore, considering all the investment alternatives, stocks are looking more attractive versus all other reasonable investment alternatives.
No positions in stocks mentioned.
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