Amid all the worries Ben carries on his shoulders about the viability of the US economy, he has to constantly be aware of the shifting moods of the players, consumers, and business people, in the current unfolding economic drama. Ben knows what he needs most right now is a catalyst to lift the "animal spirits" of the players so they will return to more normal consumption and investing patterns.
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There has, however, been lots of good news in the earnings reports of major corporations. But with all of the ill winds in the economic news, many investors have concluded that these earnings increases are the result of expense reductions and layoffs and will only make the US economy worse.
Ben is smiling because he knows the earnings are real, and that rising earnings will ultimately lead to job growth. He also knows that rising stock prices in the face of poor economic news are a good sign because it means that investors are beginning to look through the current malaise to better times.
The utility index breaking to a new 12-month high is important because, as we have said before, utilities are generally considered to be bond substitutes. Their dividend yields are more than double that of the average stock; they usually operate with some kind of monopoly power, and their financial ratings are higher than the average stock.
History shows us that almost all major turn-arounds in stocks have been led by the utilities. As investors become more confident and begin to move out of bonds, their first landing place is usually in the stock sector they consider to be the safest. For most people that is the utilities. Thus, it is not surprising that in the recent uptick in stocks, utilities have broken above their 12-month highs, while the S&P 500 Index is still nearly 3% under its 12-month high. We would expect that the S&P 500 will follow the utilities lead and break to a new intermediate high by the end of the year.
This move will be driven by the recognition that stocks are cheap compared to bonds and that Ben will see to it that bond yields won't be rising anytime soon.
3 comments:
Please elaborate - stocks are cheap relative to bonds, but are they cheap relative to the risk of holding equity at these levels, even if there is a chance for a meager 3% capital appreciation (seems weak compared to the 22+x normalized Schiller P/E)?
The current dividend yield on the S&P is around 1.8-1.9% - drastically lower than historic levels largely given Ben Bernanke's insistance on punishing savers in favor of corporations.
While stocks may in fact go higher, Mr. Bernanke is getting his inflation already - look at soft commodity prices such as corn, wheat, sugar, oil, etc. over the past few months.
Not exactly beneficial for the middle class when viewed in concert with stagnant wages and high levels of unemployment.
So rally on Wall St. But look out for weak consumer spending and margin pressure down the road. In my view, that's not worth the 1.8% dividend with a "chance" at a little upside.
Thanks for your comments.
Bob
By Bloomberg's tally, stocks are now selling at about 15 times earnings. I'm not sure where you are getting the 22x Schiller normalized PE. I did read in Google how it is calculated but I'm not sure of its relevance in this case. At 15 times earnings stocks are selling at 6.7% earnings yield compared to a 2.5% yield on a 10 year T-bond. That is a 4.2% spread. The spread over the last 80 years has been just over 3%. Thus, from this simple perspective stocks could be selling 25-30% under their fair value in this low interest rate enviroment. There are lots of arguments against this line of reasoning, but this is the way I see it. The Warrent Buffetts of the world, look at earnings yield when they buy a company because that is what their rate of return is if they own the whole company.
Finally, I don't agree with your 3% growth notion at all. I'm not debating for debating's sake. I'm talking to lots of companies and they are saying they can grow near 10% per year over the nest 5 years.
I agree with many of your comments about how badly the savers are being treated, but Bernanke is dead set on forcing the banks to stop hoarding their capital and start taking risks again. In my mind the Fed is also pushing savers out of certificates and easy places to go, into more risky places. It may not sound right to do so, but the system is forzen up and has to be dethawed.
Bernanke's strategy is risky, but they are risks that must be taken.
Thank you for your thoughtful and respectful comment. Fire away again and I'll try to zero in a little closer to my view of things.
Greg:
Thanks for your response. The Schiller P/E data is readily available - he produces earnings on a 10 yr inflation-adjusted basis.
If we split the difference on multiples - i.e. 15x vs. 22x - we arrive at an earnings yield right around 5.4%, or inline with the 3% spread above the 10 yr you noted over the past 80 yrs.
I'm inclined to use earnings smoothed over time (via the Schiller model) because it normalizes profit margins across the business cycle. I think we could agree that profit margins are destined to decline going forward given the recent movement in commodities prices without a subsequent pickup in aggregate demand (see Kimberly Clark release the other day).
The Fed is encouraging speculation - nothing more and nothing less. This will do nothing for the real economy - as did the tech wreck, housing bubble, oil bubble, etc. - over a longer term investment horizon (i.e. 3-7 years).
Please see fund manager John Hussman's recent musings for details on the liquidity trap.
http://www.hussmanfunds.com/wmc/wmc101025.htm
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