We believe there are major differences in market valuations, economic prospects, leverage on personal and corporate balance sheets and government policies. All indications are for continued 2% US GDP growth and 3.2 % global GDP growth rather than another boom - bust cycle. While the S&P 500 has rallied 13% from the November 2012 lows, earnings have come in strong so far in Q4 2012 with more than 60% of companies beating expectations. Corporate profits will come in around $100 for the S&P 500 in 2012 and are expected to rise to perhaps $110 for 2013. Morgan Stanley’s research group, however, expects only $98 in S&P 500 earnings in 2013.
I find it noteworthy that in March of 2000 with the S&P 500 high of 1527 and in October 2007 at all time highs of 1565, earnings were $66.97 and $93.36 respectively. At present we have higher earnings with lower P/E ratios and much lower interest rates, some 4% lower. After both prior peaks corporate earnings plunged 52% and 86% within two years. As we know in hindsight, this was the result of the NASDAQ bubble and the recession that followed plus terror attacks in 2001. In 2008 we experienced a housing bubble, financial panic and global recession all due to excess leverage in the system.
Since 1960 yields have ranged from 15% in 1981 to as low as 1.4% last summer. At the same time P/E ratios on the DIJA have ranged from about 27 times earnings 1929 and 1999 to as low as 7 times in the 1930’s and 7 times again in the mid-1970’s. Yes, this time things are different, however with huge government debt in the developed countries the stage may be set for the bursting of a government created bond bubble.
We are concerned about the high level of government debt and the potential for higher inflation, yet the gold price has retreated for 5 months in a row. The GLD, Exchange Traded Fund sits 12% below its October 2012 high and 17.7% below its August 2011 peak. In February gold ETF assets dropped 4%, the most since April of 2008.This is not a sign of impending inflation.
With the yellow metal sitting near bear market territory and treasury bonds near historical low yields we ask: where can investors make a decent return on their money? The surprising answer seems to be US stocks.
At 1514 for the S&P 500 the P/E is likely to be 14.5 times forward earnings. In spite of the recent price rise, the market sells below its midrange historic average of 17 times. With 10 year treasury yields at 1.88%, stocks carry an earnings yield of $104/1514 or 6.86%, also exceeding the 6% yield available on so called “junk” corporate debt. We are optimistic that bond yields will remain steady this year but it is likely US stocks will outperform bonds.
As for the Sequester scare, we believe that $85 billion in cuts will not sink the $16 trillion, US economy. At merely 2.25% of the total US budget, Washington will learn cuts won’t hurt and may even help as a rising US dollar seems to indicate. As long as the world views the US as a safe haven we will not see a run on the US dollar nor the US stock or bond markets that many fear. Reducing deficit spending will eventually be viewed in a positive light.
Indeed a correction in stock prices may be overdue but in the past years mid-April has turned out to be the preferred selling point for investors.
In our bond portfolios we continue to seek low duration higher credit risk bonds. If we can manage to avoid a US or global recession in 2013 reasonable returns should be available in both stocks and shorter duration bonds.
Douglas Coppola
March 1, 2013
