We have seen some strong advances in stock markets around the world these past few weeks. The Standard & Poor's 500 Index has risen 50 percent since its low on March 9th. It's up over 12 percent since the start of the year.
A dramatic rise of such proportions leads me to ask, what else can go right? Is there any more good news out there? First, recall the news of the past few weeks:
• The Federal Reserve releases charts intended to show the probability of a recession in the following twelve-month period. During 2008, it got just above 40 percent. At the end of July 2009, it was 0.09 percent.
• Our National Unemployment Rate decreased in July from June (to 9.4 percent from 9.5 percent) which meant that July saw the fewest job losses since August 2008.
• The U.S. Institute of Supply Management Manufacturing Index is back to where it was in August 2008, and if the July figure were to be annualized, it would translate into 2.4 percent annual growth in Gross Domestic Product.
• July's Worldwide Institute of Supply Management Manufacturing Indices were also strong with China at a 12-month high, U.K. at a 16-month high, and the Euro Zone at an 11-month high.
And then there is some less exciting, but going the right way, news:
• The Case-Shiller Index calculated from data on repeat sales of single-family homes using an approach developed by economists Karl Case, Robert Shiller and Allan Weiss, have shown a slower decline in housing prices for four months in a row.
• Credit Card Delinquencies at American Express and Discover have declined for Three Straight Months.
These events created a lot of optimism. Abby Joseph Cohen, senior investment strategist at Goldman Sachs, was on CNBC last week and said that we are in a new Bull Market. Ned Riley, CEO of Riley Asset Management and a widely regarded commentator (also on CNBC) said that he thinks the Dow will hit 14,000 in the next 18 months (that would be another 50 percent).
Nonetheless, there are some cross currents developing. I have frequently said that the stock market does not reflect the economy; it predicts it. Looking out six months, can we predict a better economy? I don't see a totally rosy picture. We will certainly continue to have horrible job numbers and housing valuations will take a long time to recover. Thank Gaia or God that the federal government is spending. There are only three main customers: government, businesses, and people. Right now, government is the only rock solid spender. Paul Krugman's recent column in The New York Times estimated that instead of 9.5 million, we'd have 10.5 million people out of work today were it not for federal spending.
Given low consumer and business spending, what will help companies earn more? Are stocks still cheap enough to grow from here? Again, this isn't totally rosy. Companies will almost certainly pay higher taxes, which will feed into valuation models and make their stock prices seem less attractive. And some important industries (financial services and health care) will be operating under new rules, rules that may (I'd say ought to) impede their earnings power.
Globally, if you use MSCI World as your guide, Financial Services companies are the single largest sector of the stock exchanges, representing 20 percent of global markets (Information Technology and Energy are just over 12 percent each). We know these companies will likely face restrictions on some of their more lucrative business practices (like predatory lending). Changing their profit structures could weigh on markets in the short-term - though clearly an essential shift for the rest of the markets over the long-term. We need financial institutions that provide capital for economic growth. It is time for banks to get back to that business and out of fee-driven (charge you for late payments) and speculative (exotic swaps) lines. Capitalism became successful because it worked for most people. Finance greased the wheels of capitalism. That's its purpose.
So I acknowledge a shake up of a big sector. But on the other hand, I see very high (A-rated) quality companies behaving kindly to shareholders. Even in this difficult environment, several of our high-quality companies such as Automatic Data Processing, Colgate-Palmolive, Expeditors, and Procter & Gamble, have raised their dividends by 10 percent or more since 2009 began. In addition, across the board second quarter earnings were pretty good, causing Wall Street analysts to raise their earnings predictions.
Finally, I haven't mentioned that my single largest concern, curbing excesses by Wall Street, seems finally to be taking center stage. The so-called naked short sales are banned (you have to borrow stock before you sell it). Senator Charles Schumer of New York has made a cause of flash trading, and I'm relieved that he did, as it clearly entails some form of front-running which jeopardizes the integrity of the markets and puts investors at a disadvantage. It now looks like hedge funds will have to register with the SEC and reveal trading positions. Further the new Consumer Financial Protection Agency will likely ban mandatory arbitration in consumer credit agreements. This has already altered behavior at some credit card companies, according to The Kiplinger Letter. I watched the webcast of the first meeting of the Investor Advisory Committee to the Securities Exchange Commission (SEC). The voice of responsible investors was clear in declaring transparency and disclosure as their top concerns.
These things give me much comfort. Normal markets need good policing.
So with the market having recovered somewhat, we go back to basics. We choose stocks that have good earnings momentum and can generate their own growth even when the economy at large is somewhat stagnant. We also look at portfolios to see how much is in stocks versus cash and other vehicles, being sure we like the allocations. We are happy to be investors in high-quality stocks because they are being most generous with dividends.
What to watch from here? For me it is the war. This is the Achilles heel for this administration. Iraq seems to be easing us out and we are leaving, but Afghanistan was a big gamble. If the popular press can be believed, we are doing much more to stabilize the nation than we were six months ago. I hope so. But today (August 11, 2009), The New York Times "Names of the Dead" lists five young service personnel reported killed in Afghanistan yesterday. It's a long way from over.
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