May 20, 2013
The numbers game
The major market averages setting all-time highs should be cause for celebration. New highs, however, are becoming old hat. The financial press mentions them, but they only get a passing notice, not the headline-style attention they got only a short while ago.
One of the more intriguing statistics so far this year is that the year to date point gain in the Dow Jones Industrial Average is close to matching the record for an entire year. The S&P 500 is more than 150 percent above its recession-induced low set March 9, 2009.
More companies increased their dividends in April than for any April in the previous nine years. Last year more than 60 percent of the companies in the S&P 500 increased their dividends, which also was the greatest number of dividend hikes in nine years, and the percentage of S&P 500 companies paying a cash dividend reached its highest level since 1998. Aggregate earnings for the S&P 500 companies are on pace to reach the highest level on record.
It might seem reasonable to think that these data and the market’s unwillingness to succumb to anything more substantive than a day or two of weakness would instill confidence. However, as the American Association of Individual Investors weekly poll of market sentiment last week showed, the percentage of investors with a positive market view is not even close to where it was a year ago.
The market has moved too far, too fast. Earnings at this level are unsustainable. Washington is a fiscal circus. Interest rates only have one way to go which is up and that will kill the market.
These along with many other “reasons” comprise the thinking that keeps investor sentiment uncharacteristically negative for this point in a market cycle.
Some investors worry that the market is nearing a major peak, which is stopping them from establishing new equity positions or adding to existing holdings. They fret that the market fundamentals do not support the market‘s current level.
But compared to the market’s last major cycle peak, stocks are cheap.
In 1999, right before the major market peak in 2000, total S&P earnings were $53 with $16 in dividends. Today the S&P 500 is earning double that amount and the index components are expected to pay out twice that amount in dividends this year and companies are setting records for share repurchases. The current S&P 500 trades for a PE of 14 versus 33 last in 1999.
In terms of a typical market multiple, we find that the S&P 500 today only is in a middle of a wide historical range. If the market reached the multiple often seen at major peaks, based on current earnings the S&P 500 could reach up to nearly 2000.
The speed of the market’s rise off the interim November 2012 low has some investors worried that the move might have propelled stock prices beyond reason.
A little perspective is in order.
The S&P 500 closing low of 667 in March 2009 largely was the result of the credit crisis that stemmed from mortgage abuse. But circumstances were not much different in 1990 when a crisis in savings and loans, which also mostly was driven by mortgage lending, drove the market sharply lower.
As the S&L crisis eased, stock prices rallied.
The chart on the left shows the two phases of the market recovery from the S&L-induced market drop. (the charts noted this text are in the complete report that is attached to this email)
The line marked with an “A” was the gradual but still hesitant market increase. The “B” line shows what some people called a parabolic move once the credit crisis was a distant item in the market’s rearview mirror.
The next chart illustrates the movement off the March 2009 low to last Friday’s close. The two charts are not identical but both portray an aggressive market move from a credit-induced low that some people today are calling a parabolic move.
Of more relevance is what the S&P 500 did following the more than four-year run higher from the S&L credit crisis low.
Instead of succumbing to the same negatives we hear today that the market has moved too far too fast, the S&P went on to post regular recovery highs as illustrated in the third chart – an eventual rise of about 130 percent above its close at the end of 1995 to its peak in 2000. Investors that were victimized by the conventional wisdom in 1995 that the market had moved too much missed a major portion of the ultimate move.
The 1990’s produced what almost anyone would characterize as a secular bull market – one in which prices move higher over an extended period in contrast to much shorter-term moves that often are called cyclical bull markets.
For slightly more than 8 years following the 2000 peak, the market was in a secular decline – a long and relatively steady slide offset only by brief rallies.
But what if –
What if the 2009 low was the starting point of a new secular bull market? If it was, the well documented history of the market swinging from secular bear to bull market phases would suggest there is a lot more time left for the market to go higher. Secular bull markets do not die in five years. They often can extend for considerably longer than a decade.
It is a mistake to think that a secular bull market will produce an uninterrupted straight line higher. Often there are relatively brief corrective periods, but they are resolved by the market resuming its uptrend.
Numerous technical indicators today suggest the conditions are present that often lead to a pullback, but they also suggest that a pullback would be temporary and probably not deep, which is consistent with what typically is seen in secular bull markets.
The market’s nearly ceaseless advance of late has generated increasing discussion of whether or not this indeed is the first phase of a secular bull market just like the 1990-1995 period was only half of the time spanned by the last secular bull market. In an internal conference call with Janney Financial Advisors, Standard & Poor’s strategist Sam Stovall was quite clear in his view that we are in a secular bull market.
Considering where competing investment vehicles are now, equities continue to have significant appeal. This partly is due to the abnormally low level of interest rates.
For the market fearful, this fact, however, is another reason to avoid stocks due to the belief that interest rates can only go up.
We largely agree that the prospect of notably lower interest rates is extremely low and that rates most likely will rise. This, however, is not a rational basis to be fearful of equities. In fact it might be exactly the opposite – a reason to be even more biased toward stocks.
It is quite clear that the Federal Reserve will not lift the lid on interest rates until it is obvious the economy does not need aggressive monetary assistance. The market is likely to take this as a vote of confidence, not a sign of impending market doom.
Greater confidence often is manifested in the market’s sector bias moving toward pro-cyclical areas of the economy, which we think has been very evident in the last few weeks. This shift would not be happening if the market dreaded the possibility that the Fed will pull back on its currently accommodative credit policy. This is even more relevant today since increasing numbers of Fed members and others have suggested a Fed move to change credit policy is only a matter of when not if.
But you might be thinking about the chance for a correction?
No one rationally can say that even if we are in a secular bull market that a pullback is not possible. But in the long run does it matter? This same worry was around as the S&P 500 surpassed 1100, 1200, 1300 on its way to 1650. There were interim selling squalls that were overcome – just as you would expect in the midst of a secular bull market.
But if making partial commitments to equities at today’s levels remains difficult, you do have the alternative of “safe” investments like T Bills that at today’s rates assure you a notable inflation adjusted loss. Treasury yields on 2,5,7, and ten year paper also have an inflation adjusted loss problem, but they also would face negative price pressure when the Fed eventually backs off the rate pedal just as equities embrace the vote of confidence the Fed would show by allowing rates to go higher.
In sum at this point and with the full recognition that the market could experience a pullback at any time and without any notice, we would suggest that portfolios that largely are devoid of equities at least take partial positions. Our sector preference now is toward financial and industrial issues, particularly those with at least modest current yields or those that have a well-documented history of annual dividend increases.
Set aside the numbers game the press chooses to dramatize the market advance as they at the same time suggest it can’t continue.
This same commentary was around in the 1990’s and the market continued moving higher to the peak of the last major secular bull market.
If, after a nearly decade long secular bear market, we have turned toward a secular bull phase, the rise in the market is far from done in time or magnitude.
Have a great week.
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