Investors are fearful as 2010's first half draws to a close. That's a sea change from as recently as mid April, when benchmark stock indices boasted a 9%+ return year to date, and investors eagerly piled into equities.
Until recently, the big concern was how soon was soon when it came to the Federal Reserve withdrawing liquidity from the economy. Inflation hawks warned of a surging rebound causing damaging inflation, and admonished the Federal Reserve to raise the Federal Funds rate and sell off assets from its bloated balance sheet if we wanted any hope at all for price stability.
Although record high unemployment caused concern, many April bulls saw past the issue, pointing to strong economic indicators and even the stock market itself to argue that a job rebound was inevitable. To be sure, naysayers pointed out that consumers constitute 70% of the economy and without job security their spending would be muted. But, the bulls responded that the unemployment rate was a "lagging indicator," meaning it would only improve after stocks and the economy were in full rebound mode.
Stocks began to weaken by the second half of April amid fears that Greece, and indeed other European countries like Spain, Portugal, Ireland and Italy, could default on their sovereign debt. A flight to quality ensued as investors piled into gold, US Treasury bonds, and the Dollar. It echoed similar panicky moves in the wake of the Lehman bankruptcy. Global stock markets swooned.
May 6 featured the flash crash, in which the US stock market dropped nearly 10% in 10 minutes, with some blue chips trading briefly for only a penny. Mutual fund investors began withdrawing money from equity funds, spooked by regulators having no sound explanation for this near collapse.
Meanwhile, arguably the greatest environmental disaster to ever strike this country, the BP oil spill, has saddened and angered the world, raising the specter that we are not in control of our energy resources and environmental destiny. Energy stocks have been sold en masse, as fear of moratoria on future drilling, expensive new regulation, and more shoes to drop have caused investors to exit in droves.
As the Dow lost nearly 8% in the worst May since 1940, investor sentiment deteriorated sharply. Concerns that conditions are worsening on Main Street were heightened when the May jobs report showed just 41,000 new private sector jobs created. That was followed by data showing a surprising 1.2% drop in May retail sales.
With the Dow now down 2.1% as we approach mid year, investors want to know whether this is the time to get in or get out of this crisis plagued market.
Outlook in a Nutshell
We believe the stock market can climb nearly 10% this year from current levels, assuming the low prevailing interest rates continue and a gradual recovery from recessionary conditions. The Federal Reserve has no plans to raise interest rates for the balance of the year, providing a benign monetary policy backdrop. The US economy is slowly getting traction, as confidence improves and the job market stabilizes.
Of course, a more severe slowdown in Europe, a far more rapid cooling of the Chinese economy, and an inability to solve the disastrous oil leak in the Gulf all could prove obstacles to an otherwise constructive outlook.
Valuations
The major market indices are down for the year, they are still off nearly 35% from their October 2007 highs, and they are now where they were 11 years ago. Meanwhile, corporate profits have doubled over the last decade. Clearly, stocks are not over valued.
To be sure, we don't have the mouth watering yields and valuation ratios of March 2009, when the Dow hit 6,500 and the dividend yield was well north of 4%. The yield on the S&P 500 is just 2%, hardly overwhelming when you realize that historically almost half of the market's return has come from dividends.
But, the situation looks more favorable when you consider that not only have corporate profits doubled in the last decade but interest rates are just half of what they were then. As a result, when you compare stocks' earnings yield (the inverse of the price to earnings ratio) to investment grade bonds' yield, you have the biggest difference in favor of stocks in three decades.
Double Dip?
There's no question that recent weakness in the economy, namely the weak May jobs report and retail sales, have fanned fears that the economy will slip back into recession.
Although certainly possible, we think it unlikely. Jobs have grown in six of the last seven months, a far cry from 18 months ago when job losses were nearly 750,000 monthly. Many metrics on the health of the manufacturing and service sector are now showing growth. Consumer confidence is improving.
No question, a relapse would not bode well for stocks. But, we believe that a cyclical rebound is under way, and investors should tilt their portfolios to equities to reflect that likelihood.
Bullish Signs
Certain sentiment indicators are now flashing a green light for equities. Insiders have ramped up purchases relative to sales, suggesting they see value in the market. Retail investors have been fleeing equity mutual funds; that is a contrarian indicator because when retail investors get skittish, markets often move higher. Skittishness often reflects recent poor performance, and the stock market is nothing if not cyclical.
Recent media coverage and headlines reflect a bearish take on the outlook. For example, one national news magazine questioned whether 401Ks should be allowed to continue. Again, historically, this coincides with attractive entry points.
But Lingering Concerns
To be sure there's the usual litany of concerns that the market must overcome. Foremost is the sovereign debt crisis in Europe. Weakness among the southern Euro members, a/k/a the "PIIGS", is transmitted to the European banks, which hold much of their debt, who in turn have important relationships with US based financials.
Moreover, the required austerity to overcome Europe's debt crisis will crimp its growth and thus growth globally. Euro currency weakness will prove a headwind to our multinationals competing with Euro sourced goods and services. Moreover, Euro profits, when translated back into Dollars by our multinationals, will total less, given the near 20% recent fall in the Euro's value.
One of the key hoped-for engines for global growth, a strong Chinese economy, appears to be cooling. Policymakers there are taking tightening measures to cool a property market that's risen consistently for 12 straight months
Moreover, taxes are going up. No economist endorses raising taxes to fight recessionary conditions, as it reduces aggregate demand and saps consumer confidence. State and local taxes are on the rise, too, which will also prove a headwind.
Energy Stocks: Have They Replaced Financials as the Market's Whipping Boy?
The passions unleashed by the frustrating situation in the Gulf threaten to drag down the energy industry with additional costs and regulation, plus halt drilling projects. Will it be the energy industry or ultimately consumers that pick up the tab?
From an investor's point of view, the market seems to have priced in the belief that the industry itself will bear the costs entirely. It would be a nice scenario to know that we have more environmentally friendly fossil fuel access at a cheaper price; unfortunately that's probably a pipe dream.
With supplies still tight worldwide amid Chinese and other emerging markets' voracious demand, and economical sources of alternative energy years away, investors need to brace for a rebounding economy pushing fossil fuel prices higher.
A great hedge on that scenario are energy stocks, particularly your large integrated oil companies, on both sides of the Atlantic, which are offering low valuations and above average dividends. Exxon, Chevron, Royal Dutch and Total are four with the greatest heft and diversification.
Financials: Buy the Dip?
The market's punching bag through most of the bear market, at least until the energy complex had to take cover, financials have had a remarkable comeback since the market's bear market lows. An ETF that tracks the sector is up nearly 175% from March 2009 until late April of this year. This rise corresponded to a big surge in profitability as interest rates declined and provisioning for bad loans slowed, as financials' profits soared 165% from a year ago.
However, amid the market's pull back financials have performed poorly, with the S&P financials down 15.3% since its high point in April; two of the largest players, JP Morgan and Bank of America, are each down 20%.
The culprits causing the decline include uncertainty over the proposed financial reform package and a surge in real estate foreclosures. Financial reform is still a moving target, as the final provisions are unclear, but it will require banks to limit proprietary trading, employ less leverage, and restrict their fee structure for various consumer loans.
Nevertheless, banks are still cheap, particularly when measured against book value. Assuming the economy continues its gradual rebound, the larger banks seem particularly well positioned; they can probably navigate best a more restrictive regulatory environment.
Gold: Is it the Real Deal?
Although we have no problem with clients maintaining a very small percentage of their nest egg in gold, we are not currently recommending new gold investments at today's very high prices.
Gold pays no interest. Gold is not used up, but simply moved from one hole (the mine) to another hole (a vault), so it could come back on the market in a big way at the right price. We appreciate that it could serve as an inflation hedge, but we think investments in energy companies offer a more compelling way to hedge that concern and collect income along the way.
It is nearly impossible to value gold, because traditional metrics like price to earnings ratio don't apply. Gold has been on a tear, having risen nearly 6 fold since 1999, and so it could be due for a rest here if not be deemed to be in a bubble; this out performance makes us wary.
In sum, we are constructive on the market, favor the financials and energy, but are cautious on committing to gold at today's prices.
David Dietze
Point View Financial Services, Inc.
http://www.ptview.com
Until recently, the big concern was how soon was soon when it came to the Federal Reserve withdrawing liquidity from the economy. Inflation hawks warned of a surging rebound causing damaging inflation, and admonished the Federal Reserve to raise the Federal Funds rate and sell off assets from its bloated balance sheet if we wanted any hope at all for price stability.
Although record high unemployment caused concern, many April bulls saw past the issue, pointing to strong economic indicators and even the stock market itself to argue that a job rebound was inevitable. To be sure, naysayers pointed out that consumers constitute 70% of the economy and without job security their spending would be muted. But, the bulls responded that the unemployment rate was a "lagging indicator," meaning it would only improve after stocks and the economy were in full rebound mode.
Stocks began to weaken by the second half of April amid fears that Greece, and indeed other European countries like Spain, Portugal, Ireland and Italy, could default on their sovereign debt. A flight to quality ensued as investors piled into gold, US Treasury bonds, and the Dollar. It echoed similar panicky moves in the wake of the Lehman bankruptcy. Global stock markets swooned.
May 6 featured the flash crash, in which the US stock market dropped nearly 10% in 10 minutes, with some blue chips trading briefly for only a penny. Mutual fund investors began withdrawing money from equity funds, spooked by regulators having no sound explanation for this near collapse.
Meanwhile, arguably the greatest environmental disaster to ever strike this country, the BP oil spill, has saddened and angered the world, raising the specter that we are not in control of our energy resources and environmental destiny. Energy stocks have been sold en masse, as fear of moratoria on future drilling, expensive new regulation, and more shoes to drop have caused investors to exit in droves.
As the Dow lost nearly 8% in the worst May since 1940, investor sentiment deteriorated sharply. Concerns that conditions are worsening on Main Street were heightened when the May jobs report showed just 41,000 new private sector jobs created. That was followed by data showing a surprising 1.2% drop in May retail sales.
With the Dow now down 2.1% as we approach mid year, investors want to know whether this is the time to get in or get out of this crisis plagued market.
Outlook in a Nutshell
We believe the stock market can climb nearly 10% this year from current levels, assuming the low prevailing interest rates continue and a gradual recovery from recessionary conditions. The Federal Reserve has no plans to raise interest rates for the balance of the year, providing a benign monetary policy backdrop. The US economy is slowly getting traction, as confidence improves and the job market stabilizes.
Of course, a more severe slowdown in Europe, a far more rapid cooling of the Chinese economy, and an inability to solve the disastrous oil leak in the Gulf all could prove obstacles to an otherwise constructive outlook.
Valuations
The major market indices are down for the year, they are still off nearly 35% from their October 2007 highs, and they are now where they were 11 years ago. Meanwhile, corporate profits have doubled over the last decade. Clearly, stocks are not over valued.
To be sure, we don't have the mouth watering yields and valuation ratios of March 2009, when the Dow hit 6,500 and the dividend yield was well north of 4%. The yield on the S&P 500 is just 2%, hardly overwhelming when you realize that historically almost half of the market's return has come from dividends.
But, the situation looks more favorable when you consider that not only have corporate profits doubled in the last decade but interest rates are just half of what they were then. As a result, when you compare stocks' earnings yield (the inverse of the price to earnings ratio) to investment grade bonds' yield, you have the biggest difference in favor of stocks in three decades.
Double Dip?
There's no question that recent weakness in the economy, namely the weak May jobs report and retail sales, have fanned fears that the economy will slip back into recession.
Although certainly possible, we think it unlikely. Jobs have grown in six of the last seven months, a far cry from 18 months ago when job losses were nearly 750,000 monthly. Many metrics on the health of the manufacturing and service sector are now showing growth. Consumer confidence is improving.
No question, a relapse would not bode well for stocks. But, we believe that a cyclical rebound is under way, and investors should tilt their portfolios to equities to reflect that likelihood.
Bullish Signs
Certain sentiment indicators are now flashing a green light for equities. Insiders have ramped up purchases relative to sales, suggesting they see value in the market. Retail investors have been fleeing equity mutual funds; that is a contrarian indicator because when retail investors get skittish, markets often move higher. Skittishness often reflects recent poor performance, and the stock market is nothing if not cyclical.
Recent media coverage and headlines reflect a bearish take on the outlook. For example, one national news magazine questioned whether 401Ks should be allowed to continue. Again, historically, this coincides with attractive entry points.
But Lingering Concerns
To be sure there's the usual litany of concerns that the market must overcome. Foremost is the sovereign debt crisis in Europe. Weakness among the southern Euro members, a/k/a the "PIIGS", is transmitted to the European banks, which hold much of their debt, who in turn have important relationships with US based financials.
Moreover, the required austerity to overcome Europe's debt crisis will crimp its growth and thus growth globally. Euro currency weakness will prove a headwind to our multinationals competing with Euro sourced goods and services. Moreover, Euro profits, when translated back into Dollars by our multinationals, will total less, given the near 20% recent fall in the Euro's value.
One of the key hoped-for engines for global growth, a strong Chinese economy, appears to be cooling. Policymakers there are taking tightening measures to cool a property market that's risen consistently for 12 straight months
Moreover, taxes are going up. No economist endorses raising taxes to fight recessionary conditions, as it reduces aggregate demand and saps consumer confidence. State and local taxes are on the rise, too, which will also prove a headwind.
Energy Stocks: Have They Replaced Financials as the Market's Whipping Boy?
The passions unleashed by the frustrating situation in the Gulf threaten to drag down the energy industry with additional costs and regulation, plus halt drilling projects. Will it be the energy industry or ultimately consumers that pick up the tab?
From an investor's point of view, the market seems to have priced in the belief that the industry itself will bear the costs entirely. It would be a nice scenario to know that we have more environmentally friendly fossil fuel access at a cheaper price; unfortunately that's probably a pipe dream.
With supplies still tight worldwide amid Chinese and other emerging markets' voracious demand, and economical sources of alternative energy years away, investors need to brace for a rebounding economy pushing fossil fuel prices higher.
A great hedge on that scenario are energy stocks, particularly your large integrated oil companies, on both sides of the Atlantic, which are offering low valuations and above average dividends. Exxon, Chevron, Royal Dutch and Total are four with the greatest heft and diversification.
Financials: Buy the Dip?
The market's punching bag through most of the bear market, at least until the energy complex had to take cover, financials have had a remarkable comeback since the market's bear market lows. An ETF that tracks the sector is up nearly 175% from March 2009 until late April of this year. This rise corresponded to a big surge in profitability as interest rates declined and provisioning for bad loans slowed, as financials' profits soared 165% from a year ago.
However, amid the market's pull back financials have performed poorly, with the S&P financials down 15.3% since its high point in April; two of the largest players, JP Morgan and Bank of America, are each down 20%.
The culprits causing the decline include uncertainty over the proposed financial reform package and a surge in real estate foreclosures. Financial reform is still a moving target, as the final provisions are unclear, but it will require banks to limit proprietary trading, employ less leverage, and restrict their fee structure for various consumer loans.
Nevertheless, banks are still cheap, particularly when measured against book value. Assuming the economy continues its gradual rebound, the larger banks seem particularly well positioned; they can probably navigate best a more restrictive regulatory environment.
Gold: Is it the Real Deal?
Although we have no problem with clients maintaining a very small percentage of their nest egg in gold, we are not currently recommending new gold investments at today's very high prices.
Gold pays no interest. Gold is not used up, but simply moved from one hole (the mine) to another hole (a vault), so it could come back on the market in a big way at the right price. We appreciate that it could serve as an inflation hedge, but we think investments in energy companies offer a more compelling way to hedge that concern and collect income along the way.
It is nearly impossible to value gold, because traditional metrics like price to earnings ratio don't apply. Gold has been on a tear, having risen nearly 6 fold since 1999, and so it could be due for a rest here if not be deemed to be in a bubble; this out performance makes us wary.
In sum, we are constructive on the market, favor the financials and energy, but are cautious on committing to gold at today's prices.
David Dietze
Point View Financial Services, Inc.
http://www.ptview.com
