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If any of you decide you want to go back through my previous notes you will know that I have continuously been "warm" on the U.S. economy. This does not mean I have been out of the market because, given the great technical picture of the market, "warm" has been good enough. I basically say warm because since the downturn in 2008 we have all been looking for the definitive proof that the market has fully recovered.
I suppose the one measure that might give this away would be if we saw a 3.5% to 4% GDP number. But 2012 was roughly around 2% and 2013 was roughly around 2.5%. And, to make it more confusing, the first quarter of this year was negative 1% (Source U.S. Dept Commerce Bureau of Economic Analysis).
So how does this GDP stuff correlate to a stock market at an all time high?
Well, I think there are a couple of dynamics at play.
First of all the yield on the S and P 500 is 1.88% while the 10 year Treasury yield is approximately 2.59% as of June 5, 2014 (Source: Bloomberg Financial). In essence, for those who want income, some may have decided to take the risk - and the potential reward - of putting money into the stock market rather than tying up their money for 10 years to receive the 2.59%.
Secondly, earnings at companies have been pretty strong. In some cases, however, this may have been do partially to stock buy-back programs. By "buying back" their own stock a company can see a rise in earnings per share simply because there are fewer shares in circulation to divide into the earnings number. If you add in the fact that some of these firms can borrow the money (at low interest rates) to buy back the stock you end up with a nice bit of financial engineering. Now it isn't even close to fair to say that these buy backs are responsible for all the earnings growth but they are responsible for some which makes stocks look better.
But, thirdly, there are some generally stronger signs for organic growth. Initial Public Offerings - which to me is a sign of risk taking and willingness to bet on the future - totaled 256 last year (Source: Renaissance Capital IPO Center) and a pretty good 140 so far this year. While it has cooled in recent weeks the IPO market is still to me a good indicator of capital flows and the emergence of the "new" companies that can grow in the coming years.
Of course stocks - or the economy - cannot survive on temporary yield dynamics, stock buy-backs, or even hopes for the IPO future. Eventually what is needed is customer demand for goods and services because this drives revenue growth, expansion, etc. So far consumer spending has been pretty good here in the U.S. but demand in Europe has continued to be weak.
Well the European problem might be receiving some attention. Today the European Central Bank has indicated a willingness to cut rates and follow some of the same stimulative programs managed here in the U.S. In addition I see signs that some of the EU countries are looking at lower tax rates as a way to attract business. Even France, given the recent election results, might consider such a crazy step.
Now I am not going to get into a political discussion here but I do want to call your attention to the fact that Europe's focus is toward stimulating the economy and getting more money into the private sector. It does not guarantee that it will be executed flawlessly but such a change of mentality has multiple impacts that I think will benefit the business and employment environment over there. Call me an optimist but the world has struggled with sluggish European demand for some years now and if this process can reignite the economies in that region then the world GDP will be better off.
Of course there are numbers out there that still aren't great. The ADP jobs reports came in with jobless claims around 312k. This level is fine but does not show an uptick.
Technical View:
I think these three charts speak for themselves but take a look at the S and P 500, the Dow Jones 30 and the Russell 3000 and you will notice something in common.
I am getting a lot of questions from people now that we are trading at all time highs. There generally seems to be a lack of confidence out there in the long term growth of the market.
Some of this I guarantee you is an overhang of the pain caused in 2008.
What next?
I have stayed bullish on the market for a few years now and I continue to be.
There are plenty of arguments out there that the fundamentals of the economy are not strong enough to sustain these moves, or that the liquidity levels have simply driven up the asset prices. I agree to some extent but many companies are run by very smart people. It is true that buy-backs and some of the financial engineering will not last forever but, given some of the other numbers I see, I believe that top line demand will start to appear. In this area I am particularly watching the spending levels in the final quarter of this year as a tell.
The consumer, which many feared would not return given the drastic loss of wealth in 2008, seems to me less concerned. And while consumer debt levels have dropped (a good thing) consumer spending has not dried up and we still buy stuff. That's a good thing for our economy.
As for the technicals I love new highs. Sure there are risks and I expect pullbacks periodically but when I see newer stocks doing well and the emergence of new technologies I get more comfortable that money will not run from the market but will simply seek those companies with better long term prospects.
Now all that being said, make sure you manage your own money with a level of discipline. While I like the market it does not mean that you push all your chips on the table for one spin of the wheel. Continue to look at different asset classes and diversify according to your needs and risk tolerance.
The mistake I see made here quite often by individuals and professionals alike is that they press. A great year like last year and greed starts to show its ugly head. Remember, as always, that "Bulls make money, Bears make money, but Pigs get slaughtered". Perhaps not a nice word picture but an accurate description of what happens when greed starts to run your investment decision process.
In the meantime, have a great summer and I will be back to you in a month or two depending upon what transpires in the markets.
Cheers-
Tim
Tim Withers is Chief Investment Officer of MSW. He has over 20 years of experience managing money on both an asset allocation and tactical basis for clients as well as serving as investment analyst to qualified retirement plans and individuals. He holds a BA from Connecticut College and an MBA from the Wharton School at the University of Pennsylvania.
Endnotes:
1. http://www.renaissancecapital.com/ipohome/news/renaissance-capitals-1q-2014-us-ipo-quarterly-review-18657.html (IPO mkt 2014)
Disclosures:
"Asset allocation does not protect against loss of principal due to market fluctuations. It is a method used to help manage investment risk."
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The material is for informational purposes only. It represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events or a guarantee of future results. It is not guaranteed by NFP Securities, Inc. for accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security.
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