Hurricane Sandy’s Potential
Economic Impact
Our thoughts and
prayers reach out to the people of the Northeast and everyone who is affected
by Hurricane Sandy.
At this time, the estimated economic damage of this storm is
$30-50 billion. In the short term, we
believe this will have a negative impact on economic activity in the region and
a modest effect on overall U.S. GDP.
Sandy’s timing is particularly unfortunate because roughly 33% of annual
retail sales occur in the last 25% of the year. Additionally, the storm will provide plenty of
“noise” to distort economic data as the effects of Sandy and the cleanup are
felt for many months to come. Cataclysmic
storms are destructive and cause much human and material loss. However, history shows us that the post-storm
cleanup and rebuilding efforts stimulate economic growth by infusing capital
and increasing employment into the affected area.
The Barnyard Forecast
The Forecast is our proprietary model for predicting stock
appreciation over the next 6-18 months. Since 1990, it has correctly predicted
the direction of the market about 75% of the time. It receives its name from
the acronym used to “score” the prospects for stocks: Economy + Inflation +
Earnings + Interest Rates = Opportunity.
Each component receives a score between 0 and 2, depending upon whether
or not it is deemed to be negative, neutral, or positive for stocks. The Forecast currently scores 5 out of a
possible 8 points, which is a favorable score for rising stock prices. The current stimulative policies of the
Federal Reserve are the primary drivers of the model’s positive forecast. Whereas, the most recent flat corporate
earnings pulled down the model’s score.
Positive Analysts’
Earnings Estimates for 2013
Looking forward to 2013, Wall Street analysts’ current estimates
for earnings growth are nearly 10% higher than 2012. Earnings growth above 7% would move the
Barnyard Forecast to a perfect score of 8 points. Historically, stocks have produced double
digit returns when the model reaches that level.
Stocks on Sale!
The price-to-earnings (P/E) ratio reveals how much
investors are willing to pay for $1 of earnings. The most recent reading from our proprietary
“P/E Finder” model indicates that the price to earnings ratio of stocks should
be near 17. The P/E ratio is currently selling at
14.3 times earnings. Multiplying the
model’s predicted P/E of 17 times the analysts’ 2012 earnings estimates of $105
suggests a year-end value for the S&P 500 of over 1700. That is nearly 20% higher than the current
level of about 1400. In addition, our
“Dividend Valuation Model” currently estimates that stocks are 15-20% undervalued
based on the historical relationship between dividends and price. We feel this confirmation of two separate
models measuring two different indicators both arriving at the same conclusion is
convincing evidence that stocks are, indeed, undervalued.
Why are stocks trading so cheap? The answer in two words is “risk
premium.” Our “P/E Finder” model is
based on the relationship between P/E and inflation. Historically P/E ratio has moved inversely with
inflation. Investors are worried that
the Fed’s aggressive monetary policies will push inflation significantly higher. We believe inflation may move modestly higher,
but will not exceed 3% for an extended period of time. In our judgment, inflation would have to stay
above 3% for more than a year for P/Es to meaningfully fall. With this in mind, in the absence of
unforeseen shocks to the economy, we remain optimistic about 2013 stock
performance.
Fiscal Cliff
The media are full of worrisome stories about the
repercussions of a continued stalemate between the Republicans and Democrats on
a wide range of fiscal issues. The so-called
“Fiscal Cliff” is a combination of the expiration of the Bush-era tax cuts
along with across-the-board cuts in defense spending and entitlements. The consensus of the Wall Street experts we
follow is that the ramifications of not solving these issues are unacceptable
to both sides and that an agreement will be reached either before the deadline
or shortly after the new Congress takes office on January 3rd. The stakes are just too high for Republicans
and Democrats to do nothing.
The Elections
On balance, we believe the stock market would do better
under Mitt Romney than under President Obama, who’s anti-business, anti-rich
rhetoric has not endeared him to the business community. Having said this, investors will be relieved
just to have the uncertainties surrounding tax laws and the state of the U.S.
budget cleared up one way or the other. The
only thing that would derail our positive view for the stocks would be if
President Obama makes further attempts to expand the role of government at the
expense of the business community or if earnings disappoint.
As will be familiar to many readers, we rely on our models
more than we rely on the hot news of the day.
Eventually stock prices follow value.
We believe stocks are already undervalued and will become more so in the
year to come. In this environment the path of least resistance for stocks is up.
