We had a slight scare in January with markets diving on geopolitical bond default concerns among many other things. Earnings by most accounts, however, have been outstanding for the fourth quarter and some sanity has returned to the market. The focus lately has been on monetary tightening and specifically when will the Fed raise interest rates and end the flow of cheap money. Low interest rates and a declining dollar were the chief underpinnings of the stock market rally last year. (A stock becomes more valuable if the alternative (i.e. investing in Treasuries) isn't attractive because of the low interest rates.)
I believe we're in for a rough couple months or a year ahead with credit issues being worked out by local, state and global governments. Efforts to curtail the huge U.S. deficit will also weigh on the market, specifically talk of higher taxes and more punitive measures on large investment banks. The wild card will be signs of inflation and the response by the Federal Reserve.
From my perspective the U.S. stock market is fairly valued. Only another superb earnings season for the first quarter ending March 31 will drive the market higher. I do not think this is going to happen. Corporations have picked the low-hanging fruit, relying on higher labor force productivity, cost cutting, discounting and burning through cheaper inventory to boost sales and margins. I don't think this can continue. I think we're in for a slightly disappointing earnings season as the consumer really buckles down in the face of extremely high unemployment and socks away more money into savings accounts. The latest consumer sentiment report was the first sign of things to come.
I'm taking money off the table, specifically overvalued small cap funds, growth index funds and greatly reducing my exposure to Europe in particular. I'm maintaining investments primarily in high quality dividend paying funds. AIM Diversified Dividend LCEIX is a favorite and my largest long-term position.
In addition to earnings, I'll be keeping a keen eye on inflows into stock mutual funds by retail investors like you and me. Nothing spells confidence like putting money where your mouth is.
Wednesday, February 24, 2010
Friday, February 5, 2010
Into The Fire
Just as this time last year fear has gripped the stock market. We're staring at a 10% correction since the start of January. The latest fear is potential defaults on sovereign debt from countries including Spain, Greece and Portugal. In addition, the employment situation appears stagnating and long-term global growth prospects are waning.
The chances that we will see a wave of sovereign debt defaults is remote given the nature of global finance and the fear among other nations of 'contagion' - or a spreading of the crisis. The slower growth in the effected nations, however, is a real possibility. But even then, these nations only represent a small fraction (about 3%) of global GDP output. The biggest risk is to sovereign bond funds, not U.S. equity holders.
In addition to these headlines, the doomsday prophets are foretelling of a collapse of the real estate market in China, the U.S.'s growing deficit and looming tax increases and local and state government debt issues. All told, these issues will scare even the most bullish investor.
Fundamentally, the markets are driven by earnings, which rely both on access to capital and growth of capital. Right now earnings are growing at a pretty good clip, with companies exceeding estimates by 3 to 1. Investors are betting this will not continue.
I'm sticking with my long-term forecast that we will see continued growth in earnings this year, fears will ease and the stock market will rebound. If I had to call a bottom to this correction, I'd put the S&P at about 950, which would put us at an average price-to-earnings multiple of 15 for last year and the coming year (assuming earnings estimates are accurate). If earnings continue to outperform, I expect job hiring to resume and the market to rally back to above 1200.
The chances that we will see a wave of sovereign debt defaults is remote given the nature of global finance and the fear among other nations of 'contagion' - or a spreading of the crisis. The slower growth in the effected nations, however, is a real possibility. But even then, these nations only represent a small fraction (about 3%) of global GDP output. The biggest risk is to sovereign bond funds, not U.S. equity holders.
In addition to these headlines, the doomsday prophets are foretelling of a collapse of the real estate market in China, the U.S.'s growing deficit and looming tax increases and local and state government debt issues. All told, these issues will scare even the most bullish investor.
Fundamentally, the markets are driven by earnings, which rely both on access to capital and growth of capital. Right now earnings are growing at a pretty good clip, with companies exceeding estimates by 3 to 1. Investors are betting this will not continue.
I'm sticking with my long-term forecast that we will see continued growth in earnings this year, fears will ease and the stock market will rebound. If I had to call a bottom to this correction, I'd put the S&P at about 950, which would put us at an average price-to-earnings multiple of 15 for last year and the coming year (assuming earnings estimates are accurate). If earnings continue to outperform, I expect job hiring to resume and the market to rally back to above 1200.
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