As we expected, stocks are rising. Here are key themes to remember, which we have discussed before:
- Stocks are rising because they are attractively valued versus bonds and cash, and investors are more confident we won’t have a financial disaster. S&P EPS this year will be about $108 and the average trailing PE in recent decades has been around 16.5x, implying a year-end price of 1782. No, we probably won’t get that high, but we may well exceed the current year-end targets of bullish strategists, of around 1600.
- The U.S. economy is doing fairly well, to judge from important indicators like the ISM indices, auto sales, and the housing market. But employment will lag because Obama has done so many things (notably Obamacare) to discourage hiring. Don’t listen to Keynesians using single-variable models who claim weak hiring reflects weak demand.
- As in the mid-1980s, this rally is being driven by PE expansion, not earnings. The fact that earnings are rather weak (but not disastrous) does not matter when stocks are so cheap relative to bonds and cash and investors are becoming more confident we won’t have a financial disaster (the main reason to own bonds).
- Corporate America has rarely beeing better managed and more share-holder friendly, which supports PE ratios.
- As we warned, the problems in Europe continue to be severe because the real economy is in terrible shape despite Draghi’s efforts to support the financial economy. Elites in Brussels, Frankfort, and London may be happy, but citizens in the real world are not, which is why Grillo got 25% of the vote in Italy. I am suspicious that Europe will start to grow soon, given its anti-growth policies and dysfunctional currency arrangements that prevent weak economies from devaluing.
- A pleasant surprise is U.S. politics, where Republicans have been out-playing Obama for a change. By calling his bluff on sequester, they have focused attention on the specific absurdities of the Federal budget. For the first time, the media is asking why we have to have many troops in Germany, Korea, etc., and why we have so many overlapping programs. Interest groups burned by sequester (like academics) may start to appreciate the need to reform entitlements. Obama is wrong-footed and trying to figure out how to make a deal with Republicans, which will be difficult after he arrogantly dissed them for the last couple of years. His effort to blame Republicans for a law he conceived of and signed into law, and his effort to turn sequester spending cuts into tax hikes has undermined his credibility. (The notion that the sequester could involve tax hikes is particularly absurd because it was inspired by the 1980s Gramm Rudman legislaton, where sequester was very clearly about spending cuts, not tax hikes. If you don’t believe me, just google “Gramm Rudman Sequester.”) Budgetary fisticuffs will tie Obama down until this summer. Meanwhile budgetary sanity is gradually being forced upon Washington by the adults in the Republican party.
- The best kept secret on Wall Street is dividend growth. Major companies like QCOM and HD (which I own) are growing dividends 30-40%. SPX DPS this year will grow over 10%, which is very attractive in a 4% nominal GDP growth world. Investors should buy high quality companies with good dividend yields (2% or more) and dividend growth. There are plenty of no-load mutual funds containing these stocks.
- We will get a “correction,” and a mishap like a war with Iran is always possible, but U.S. stock prices are headed signfiicantly higher over the next couple of years.
