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Just last week, we laid out our view of the next leg of the secular bull market, which we termed “Goldilocks cubed.’’ Briefly, it centered on three key themes: accelerating growth should translate into accelerating earnings as revenues flow to the bottom line; second, supportive central banks and global geopolitical forces will keep long-term government bond yields from making outsized moves up—and may even cause them to decline further; and third, volatility that looks abnormally low in the context of the past seven years actually isn’t, and once the market appreciates this, it will stop trying to price in this discount. Together, these three core catalysts are driving our call for the S&P 500 to reach 2,100 this year and grind even higher in 2015.
Not surprisingly, we’ve gotten some pushback on this theme, particularly from bears who almost from the day we first initiated an equity overweight position in our stock-bond portfolio models in spring 2009 warned of more catastrophe just around the corner. Well, in the words of the young Boston lawyer (and future President) John Adams as he reluctantly but successfully defended British soldiers following the Boston Massacre, “Facts are stubborn things.’’ And, almost as if on cue, this week saw the arrival of three sets of facts supportive of our thesis:
Exhibit A: FedEx earnings
The economically sensitive shipping giant reported blowout fiscal fourth-quarter earnings (ending in May) that more than doubled the year-ago results, with revenue importantly also rising by a little less than 4% despite all the worries that something worse than the weather is driving the economy towards a pullback. A big reason for the better-than-expected improvement was a series of efficiencies undertaken over the past several years to wring $1.6 billion out of its cost structure. This is indicative of the sort of productivity enhancements much of corporate America has made and continues to make in the wake of the 2007-09 global meltdown that scared the daylights out of everyone. With pristine balance sheets and piles of cash at their disposal, the payoff is that profit growth and margins the consensus seems to think have peaked still have room to run, supporting our view of S&P earnings reaching $120 this year and moving still higher next year.
Exhibit B: Yellen reiterates dovishness
Just like her predecessors Ben Bernanke and Alan Greenspan, Fed Chair Janet Yellen made clear in her post-policymaking-meeting press conference that the central bank expects to remain very supportive for a very long time, even if it does begin to nudge the target funds rate up a little earlier than the consensus had been expecting. Her comments, which presented a relatively positive view of the economic outlook going forward, indicated the Fed, along with the European Central Bank and the Bank of Japan, will likely continue to work hard to prevent longer rates from moving up too much or too fast. What no one wants is for central banks to take steps that may stall a U.S. economy that is finally regaining its footing, a European recovery still in its early stages, and a Japanese growth spurt that has that country finally emerging from a two-decade funk. On a comparative valuation basis, this continued low-yield environment is extremely bullish for equities.
Exhibit C: Oil refinery attacked and the VIX … falls?
This is exactly what happened when ISIS terrorists laid siege to Iraq’s biggest oil refinery on Wednesday and the VIX dipped below 11. If a new wave of attacks by Islamic extremists isn’t enough to cause this so-called “fear’’ gauge to spike, particularly given Iraq’s place in the global oil market, what is? What this tells us is that the market no longer is on pins and needles, with every disruption sparking a large risk-off trade as had been the case for much of this bull run. If anything, the VIX appears to be settling in at levels that aren’t really extreme but actually are quite normal in the context of the more distant past, before the psychological and financial damage caused by the worst global downturn since the Great Depression put everyone on edge. As we’ve noted previously, it’s taken some time but investors appear to be moving further away from the world-may-be-ending mindset and are beginning to appreciate that this “new normal” actually is a lot like the old normal, when improving economic fundamentals, healthy corporate balance sheets, supportive central banks and the lack of any real excesses are just the ticket for equities.
To review: Stronger earnings? Check. Supportive monetary policy? Check. Continued low volatility? Check. Goldilocks cubed.