Market Memo: Ben is far from stocks' only friend
Federal Reserve Chairman Ben Bernanke and his policymaking team made clear last week they have no designs on taking away the punchbowl anytime soon. Their post-meeting statement, and Bernanke’s press conference that followed, indicated they won’t even entertain thoughts about raising rates until unemployment dips below 6.5%, a level their own forecast doesn’t envision until well into 2015. Every other central bank in the world is being similarly aggressive. It’s all-in, all over.
This, of course, is bullish for stocks—and our own bullish case that has the S&P 500 reaching 1,660 by year’s end. However, most investors and commentators appear so focused on the Fed that they’re missing other key drivers of this rally, including:
- The fading Armageddon mindset A key reason the S&P 500 has been trading so cheap—14.5 times projected earnings versus the long-term average of 17 to 18 times—is that investors still shell-shocked from the global financial crisis have collectively been expecting another Category 10 financial earthquake. But every time we get through a predicted one, the correction is smaller and confidence rises. In August 2011, there was a 10% pullback on Debt Ceiling I and Spain/Italy I; last December, we had a 4.5% correction on “Debt Ceiling II.” Last month, there was a short-lived 2.5% correction on “Italy III (the ambiguous but generally anti-austerity election). Now we just had “Cyprus I” and the correction lasted one day and 1%.
As more and more investors come to understand that the world is not ending and the global economy is not going bust—and that their options for yield and income elsewhere are extremely limited—they are shrugging off every new mini-crisis and inching back into stocks. While equity fund flows the first two months of the year hit a nine-year high—a sharp reversal from record outflows of the past five years—the tidal wave out of bonds into stocks hasn’t even started yet. Indeed, bond fund flows were even stronger than that of equities the first two months of the year. Once this reverses—and the growing valuation premium offered by equities relative to bonds suggests it eventually will—this should provide an accelerant for stock prices.
- The real recovery hasn’t really started On paper, the recovery from the depths of the Great Recession appears relatively long in the tooth. It turns four in June, and the average post-World War II expansion is less than five years. But the reality is two major drivers, housing and autos, are only now springing back to life. Housing is finally emerging from a seven-year bear, with starts still 50% below levels typically associated with replacement and demographic demand. In fact, one of the biggest constraints on new-home sales, as we saw again this morning with February’s sales report, has been a lack of supply.
Autos are in a similar boat: Sales have been revving up but are still well below pre-recession levels even though the average age of vehicles on the road is near a record 11 years. This is fueling a rise in replacement demand, which along with a natural gas energy boom that is hastening the country’s energy independence, has manufacturing on an uptrend. Private payrolls also appear to be growing fast enough to bolster consumer spending and their confidence about their future, offsetting—at least partially—near-term concerns about higher payroll taxes and gas prices that ushered in the New Year.
- The emerging world is emerging again After several soft quarters, growth in several key emerging-market countries led by China is starting to stabilize. Our international team believes that China’s newly appointed leadership will start applying measures soon that will lead to a re-acceleration there later this year. We’re also optimistic about South Korea, Brazil, and Mexico, all of which are expected to grow significantly faster than the U.S. in this and coming years. Brazil in particular stands to benefit from a massive upgrade of its transportation infrastructure as it prepares to host the 2014 World Cup and the 2016 Summer Olympics. All of this is good for S&P earnings.
- Cyprus was a sideshow It’s less than 0.2% of European GDP and is not precedent-setting for anyone. It is a common belief in Europe (right or wrong) that a big part of the problem with Cyprus is that its banks were being used by illicit Russian interests to get money out of Russia. The European Central Bank (ECB) was simply not going to bail the Russians out; everyone understands that. This means little for depositors in Spanish banks, for instance. ECB President Mario “Whatever It Takes” Draghi is still behind Spain and Italy, and Mario Monti, by the way, is still reforming the Italian government despite February’s confused election outcome.
None of this is to suggest that times are great, only that they are more likely to get better than they are to get worse over the course of the year, with the occasional unforeseen—and in the case of Washington, the self-inflicted—bumps in the road. Growth may slow in the next few months as the sequester cuts take hold. But while it remains to be seen how deep or wide the so-called multiplier effects from reduced government spending may be, longer-term organic growth from the private sector appears to be on a self-sustaining path, now that housing is starting to kick in, manufacturing is expanding and consumers are hanging in. If the Obama administration and the Republican House were somehow able to strike a “grand bargain’’—an outcome the markets have not priced in and one that would seem unlikely—then risk for stocks would be well beyond our year-end target.
All of the above makes us comfortable with our 1,660 year-end target and our overweight equities/underweight bond positioning in our model portfolios. Quite frankly, we’ve been waiting for some time—along with a lot of others—for a 5%-to-10% correction to add our equity overweight position, and still stand ready to do. But we take solace that every move down has been followed by a move even higher—affirmation, we believe, of our ongoing secular-bull thesis (see Jan. 30’s “It’s a secular bull and here’s why” for our most recent take on this). And we continue to advise long-term investor to buy on dips; just don’t expect the dips to be very deep or to last very long.