As you know
I am a humble macroeconomist and not a finance whiz and therefore I admit to
treading in shark infested waters. What I read tells me that the risks lie
toward mean-reverting behavior. After stocks have gone up so much it seems
reasonable that they would take a breather. While that sounds pretty rational I
think that view is missing some vital information. I see several reasons why
stocks could continue rising and therefore I am more optimistic than many of
the pundits.
Let’s face
it the majority view has a lot going for. For one thing a look at stock market
behavior over time does underscore a tendency of markets to deviate from and
then return to longer term trends. And the famous PE (price to earnings) ratios
mostly support the view that stocks cannot keep up rapid price increases. Stock
prices have raced ahead of earnings – especially since earnings are slowing
down. If you expect earnings to continue to slow as the world economy struggles
then price to future earnings look high today – thus there is plenty of room
from the PE camp to suggest a slowing or a retraction in stock prices.
So how can I
support a more optimistic view of future stock prices? One point is that earnings have been volatile. During the recession them plummeted. After the recession earnings moved dramatically upward. It is natural they would fall off that rapid acceleration to something more normal. Thus, a slowing in earnings does not bode poorly for now or for the future.
My second
point is based on an even longer-term view of stock prices. I am going to use the S&P 500 average for my analysis but
what I am about to say works for most broad measures of US stock prices. The
S&P 500 bottomed out in the recession at 676 in March 2009. That
represented a major contraction relative to the heady days of pre-2008. Since
March 2009 the S&P 500 rose to around 1,800 . From the bottom in March 2009
to July 2013 the S&P 500 rose by 166%.
That is pretty spectacular and you can see why some people think that
behavior cannot be maintained.
But there is
more to the story. If you compare this so-called high stock price level in
November 2013 to the previous peak in November of 2007 of 1,520, you see that
in a time period of six years the market has gone above that previous peak but
is only 18% higher. A gain of 18% in
four years is not spectacular. Do not forget that those stock returns buy less
because the prices of goods and services were rising during those six years.
The Consumer Price Index rose by 14% in those six years. So you could conclude
that in purchasing power terms, the peak level of the S&P 500 is only about
4% higher than it was six years ago. That peak resembles the humble Smokies
more than the Rockies!
If we
compared today’s so-called high level of stock prices to the previous peak in
2000 of 1,527, then today is 18% above that peak. Today’s peak is only 18%
above the peak of 13 years ago! With inflation of 37% since 2000, the buying
power of today’s market high is about 19% less than the peak in 2000.
We have a
market high recently but when we compare it realistically to previous highs, it
doesn’t look very spectacular and therefore does not imply a major contraction
is ahead of us. The S&P 500 would have to rise from the 1,800 range to
something greater than 2,200 to be comparable in buying power terms to the peak
of 2000. I am not predicting anything
like that. But the US economy is growing. Companies are making profits. The
fear of another major global collapse is receding. Employment is gathering steam.
Smaller investors are getting back into the US markets. There is no reason why
stock prices cannot continue their upward trajectory. If only the Fed and
Congress would do their respective parts by not mucking up the economy.
Dear LSD. Bulls make money, bears make money, but pigs get slaughtered—yada yada yada. The TV yacking heads can’t agree—some say the market(s) will rise, others say fall, and other say it depends. And, well, I guess it does.
ReplyDeleteEquity prices have increased as you say. Some techonerds say ‘cause of earnings with the caveat those earnings derive from productivity boosts not revenue. Twue. Some non- techonerds say ‘cause of short-term swings whipsawed by Fed chatter, natural disasters, and other non-financial events—is it possible the great mood ring in the sky is really the wizard behind the curtain pulling the strings and turning knobs? Who knows?—the shadow does—it knows whether the increase in stocks derives purely from earnings, the mood ring, or both.
Yeah, a lot of chatter about an impending correction. Maybe, but using just the current P/E for the DOW at 16 I think stocks are reasonably priced—some bulls say they’re weally weally cheap—compared to the P/E @ mid-20s in 1990s. Assuming an overall improving economic trend, then top line increases will push earnings farther faster and P/E will follow. Then I would expect some leveling off and increased likelihood of a “correction” as profits are taken.
And, of course, the push up of stock prices also derives from lackluster bond prices that are returning squat—or scat, whatever. Maybe we should not worry and just put our cash in the mattress and avoid becoming oink oink.
Perhaps my naivete....I can't seem to get the little tilde over the last e....shows, but a major reason profits are up is because companies are doing more, or at least as much, with less, as in "employees." People are always the most costly resource, and having to pay fewer adds loads to the bottom line. I realize that the gov't recently said that we're down to a 7% unemployment rate, but the "real rate," U6 I believe, is more like 13%. By most accepted definitions, the "recession" ended; however, with high unemployment and so much economic uncertainty, I'm not too sure about that. Whatever is going on, my retirement funds are loving the market's performance!
ReplyDeleteThis comment is from James -- he had trouble getting it posted................Since 2007 consumer prices have risen 14%. Really not inflationary but consumer income did not rise at all. Spending drives production and sold products and services drive earnings ( in some sense) which in turn drives value and stock prices. Where is the beef?
ReplyDeleteEarnings did rise since 2007 but that was on the back of QE for banks coupled with very conservative lending. For the other companies it was on replacing labor with machines and computers. That replaced labor is part of the employment problem we have.
A survey taken last week showed consumer optimism far less than broker optimism….mainly because they have to think that way to promote their products/services.
Consumers prior to 2007 were using credit to make up differences in buying needs. Much of that credit was related to abusing credit cards but another large part came from using home equity as a piggy bank. That went a away and probably will not be back for a while until equity again rises faster than the average or 4% per years since 1946.
Putting this all together means that there is no natural law dictating whether stocks go up and down in a pattern. It is a gamble and even for those who know it real well, errors in judgment are made…on the flip side lucky guesses are also made and then there are others who have a tracking program that is consistent and yields moderate returns.