Market Memo: It's a secular bull and here's why
Earlier this week, Federated’s PRISM asset-allocation committee reaffirmed its secular bull-market thesis—one we first put forth in the midst of the August 2011 debt-ceiling fiasco, when it was very lonely being a bull, and seconded this past May, when yet another late-spring sell-off left many wondering just what it was we saw. But even as many point to this morning’s negative print on fourth-quarter GDP and recoil from the sausage-making process that is Washington these days, the secular-bull case from our perspective has firmed, which is why we are reinstating our overweight to equities versus bonds that had been in place in our stock-bond model through late November of 2012.
Readers of this space will note that we took profits on that equity overweight position following the U.S. election, moving our stock-bond call to neutral as the political dynamic in Washington risked a fall off the fiscal cliff and an economic soft patch, at best. Since then, the political risks have receded for the near term, and the economy both here and abroad is showing signs of recovery, this morning’s initial report on fourth-quarter GDP notwithstanding. This dip is very much yesterday’s news and in any event was driven by one-off forces that we don’t think will be repeated. It also belied some rather encouraging news on real consumer spending and both business and residential investment that should further fuel the economic reacceleration we believe is underway.
With our 1,660 target on the S&P 500 for year-end 2013 very much in play, we are advising clients to reestablish overweight equity positions in their portfolios and, should a political accident of some kind cause a near-term pullback, use that occasion to add even more aggressively to their equity positions. In short, we are in a “Buy the Dip” mode for the balance of 2013. We think the market itself is in a similar mood. Here is a summary of our top 10 reasons to own equities for 2013.
No. 1: Tail risks are receding. For sure, we’ve been talking about the gradual decline in the perceived risk of a recurrence of the “Category 10” financial earthquake of 2008 since we first took equities to overweight back in the spring of 2009. This remains a key theme. About once a year since, we’ve had some form of aftershock that at first was thought to be “the next big one:” Greece Crisis I, 2010; Greece Crisis II/U.S. Fiscal Crisis I, 2011; Spain/Italy Crisis I, 2012; U.S. Fiscal Cliff II, November 2012. Every time we go through one of these and the bottom doesn’t fall out of the world, investors become a little more convinced that the “one-in-a-hundred” event of 2008 really was a “one-in-a-hundred” event. And when this happens, they creep a little bit further out of the risk cave, and the multiple they’re willing to pay for equities goes a bit higher. At 1,500 on the S&P, equities are roughly priced at 14.5 times earnings; we see them going back to a more normal 17 or 18 times as risk concerns recede. But for this year, even with sluggish earnings, we can get to 1,660 with just a point or two of earnings-multiples expansion.
No. 2: “Don’t fight the Fed, ECB, BOJ, BOC and every other central bank in the world.” As our lead international equity strategist Audrey Kaplan recently wrote on this website, we’re in the midst of a global stimulus party, with globally synchronized central-bank easing providing fuel for growth and a backstop to potential crises. It’s difficult to be out of equities when the central banks are all in.
No. 3: Housing moves from zero to hero. What arguably was the biggest private-sector drag a year ago has become one of the biggest catalysts, with year-over-year home sales up sharply (2012's increase in new-home sales was the most since 1983), housing starts and permits are at four-year highs, home prices on pace for their first annual increase in six years, and the gauge of builder sentiment also is at a six-year high. The multiplier effect should not be overlooked, as higher home sales and prices also drive construction, remodeling, furniture and furnishings, jobs, etc. The only concern appears to be a supply issue—inventories are so low some buyers are having a hard time finding homes, a near-term drawback with positive long-term implications as the market moves to catch up to demand.
No. 4: U.S. manufacturing renaissance. Fueled by cheap and abundant sources of domestic energy (more below), stagnant wages and productivity-enhancing investment—and by opposite trends in Asia, where wages, land and other input costs are rising—American manufacturing is experiencing a resurgence. As Barron’s reported this month, companies with global operations such as Apple, Caterpillar, Ford, General Electric and Whirlpool are expanding production back home again. Foreign companies are doing the same—Samsung and Airbus are building huge new plants here and Toyota is now exporting minivans made in Indiana to Asia. This is a trend that in many ways is just getting started.
No. 5: U.S. energy production moves toward self-reliance. Manufacturing’s domestic resurgence is being fed and in some ways led by a surge in U.S. energy production. Fueled by technologies that have allowed energy companies to tap heretofore unreachable large pools of oil and natural gas trapped in shale, U.S. energy production and supplies are expected to outstrip domestic demand by the end of this decade. Not only is this creating a huge cost advantage domestically—natural gas prices here are about a third of those in Europe and a fourth of those in Japan—it is helping abet manufacturing growth as companies further up the energy production supply chain (i.e., steel pipe fabricators, industrial fittings makers, etc.) rush to supply the natural gas producers and as energy companies ship output to other countries.
No. 6: U.S. employment picture picks up. While nonfarm and private payrolls have been relatively stable and uninspiring, they nonetheless have been positive and better than expected of late. Moreover, there are indications the labor market is on the verge of shifting to a higher gear. Initial weekly jobless claims—a important leading economic and employment indicator—have fallen to five-year cycle lows in the past month, potentially signaling a breakthrough from the stagnation that marked much of last year, when claims appeared range-bound at 360K-390K. Moreover, the forward-looking ADP report on private payrolls has moved higher and is demonstrating some strength. In addition, government jobs—the big drag during this recovery because of steep cutbacks at the state and local level—has started to stabilize, with Moody’s Analytics projecting total state and local government payrolls to expand 220,000 this year.
No. 7: China soft lands and then takes off. The world’s second-largest economy surprised in the fourth quarter, as GDP growth accelerated to a better-than-expected 7.9%, ending a two-year string of declining growth. While there is debate about whether China will attain the pre-slump double-digit growth of the past decade, there’s little doubt the pace of expansion is picking up, aided by a healthier and more sustainable mix of both external and internal demand, the latter being led by a rapidly growing middle class and a new wave of government infrastructure spending.
No. 8: Brazil reaccelerates. The economy in this leading Latin American country slowed to a crawl last year, with GDP expanding by less than 1%, in large part because its export-oriented economy felt the drag of China’s slowdown and the eurozone recession. But unemployment remains near historic lows, its fiscal situation remains solid and inflation remains somewhat subdued. With China picking up and global tech and energy companies planning expansions, Brazil’s economy is projected to perk up this year and next, as the country prepares to host the 2014 World Cup and 2016 Summer Olympics.
No. 9: Europe stabilizes. With the European Central Bank committing to act as a backstop to the ongoing debt crisis, Germany’s economy appearing to have bottomed and a key eurozone confidence index rising a third straight month, it appears the worst may be behind Europe. That’s not great, but it’s enough to ease investor concerns about event-risk in Europe.
No. 10: Individuals reallocate back to equities. This may be the biggest catalyst for the market this year—and potentially years to come. After essentially abandoning equities after the dot.com collapse and global financial crisis, individuals in recent months have begun dipping their toes back into the equity waters. The New York Times, citing Lipper data, said nearly $15 billion flowed into all stock-focused mutual funds the first three weeks of the year, the most in any three-week period since 2001. Mutual funds focused specifically on American stocks collected nearly $7 billion the same period, the most in all but one comparable three-week span since the 2008 financial crisis.
To be sure, there’s a lot of uncertainty about what’s next in Washington. While there have been moves toward compromise on some issues, notably immigration and the tax portion of the fiscal cliff, very difficult and ideologically challenging decisions loom over spending and entitlements. It’s bound to get messy again. But don’t lose the forest for the trees. As the aforementioned suggests, the case for the secular bull market—one that drew more than a few dismissive laughs when we first made it a year and half ago (though we also noted at the time that the early stages of secular moves are never clear or one-directional)—is firming.