After being long and wrong in 2007 and 2008, I have been correctly bullish on stocks for the last few years, arguing they would scale the proverbial wall of worry. Bonds, on the other hand, have looked to me to be vulnerable to an eventual correction. The stock call still looks correct; the bond call may turn out OK eventually, but not for a while. Here are the key macro headlines:
- The U.S. economy is strengthening, particularly profit-relevant metrics such as—ISM Manufacturing, Industrial Production, Capacity Utilization.
- S&P Profits will be around $120 this year, higher than many estimates. (If they fall short of this figure, it will be due to the government shake-down fines on JPM, BAC, etc.—not macro drivers.)
- As expected, Europe is stagnant, not rebounding as many expected. Socialism, bank deleveraging, EU dysfunction and stagnant populations are tough obstacles to overcome.
- Emerging markets are weak and won’t improve quickly. China is not a disaster but growth will be ham-strung by persistently weak real estate.
- Therefore, central banks’ monetary policy will be super-easy, depressing bond yields. The German 10-year yield is well under 1%; Spain and Italy are around 2.5%.
- Fed policy is “behind the curve”—far too easy for the 6th year of recovery. (See the illuminating analysis by Drew Matus of UBS.) Eventually, as Chair Yellen admits, rapid and “disruptive” rate increases may be needed to address inflation. But not now. With bond yields so low in Europe, even an inflation scare may not push U.S. bond yields to levels that are ruinous for stocks.
- In this weird environment, as strategist Jason Trennert noted in Barron’s, it’s all about TINA: There Is No Alternative to stocks. Stock prices will grind higher, barring an exogenous shock.
- Stagnant Europe / improving U.S. = stronger dollar. The strong greenback and unfavorable oil market fundamentals (abundant supply / weak demand) are weighing on oil prices. Both a strong dollar and weak oil are positive for real GDP growth because they restrain inflation. But they are both headwinds for S&P profits, which are measured in nominal not real terms.
The main problem with these views is that they are close to consensus. But there are some bearish misconceptions about the macro picture. Some “Big Picture” thinkers such as Mohammed El-Erian seem to believe investors are recklessly bidding up stocks despite bad fundamentals. Actually, the PE of the market has not increased materially this year. If the S&P 500 is at 1995 by the end of September, the trailing PE on pro forma earnings will be about the same as year-end 2013 (17.1x vs. 16.8x). Another misconception is that stocks are being driven higher by buy-backs; they are only adding 1-2% to S&P 500 earnings growth.
You Heard It Here First
We shamelessly “point with pride” to some prescient observations:
Part-time America: We have been babbling for years about how Obamacare would increase part-time employment. Now a famous labor economist has highlighted the unusually “elevated number of workers who are employed part time but desire full-time work (those classified as ‘part time for economic reasons’). At nearly 5 percent of the labor force, the number of such workers is notably larger, relative to the unemployment rate, than has been typical historically.” But though she recognizes the part-time America phenomenon (a calamity for many low-income workers who must commute between two jobs every day) Janet Yellen still can’t bring herself to connect it to Obamacare, even though some recent Fed surveys have done so.
Costly CAPE. We explained why Robert Shiller’s widely followed valuation metric is useless, flashing a “red light” to equity investors for all but a few years since 1990, while stock prices sextupled. Much to his credit, Shiller admitted as much in a NYT article. But I see little evidence he understands the accounting and fundamental factors (FAS 142, lower transaction costs, less stock market fraud, better corporate governance since 2002, etc.) that justify a PE well above the average since1871. He points to low bond yields (fair enough; see above) and investor psychology.
Hedge Fund Madness. On July 5, 2013, we observed, “Hedge funds have several serious flaws that are gradually becoming recognized.” Now big pension funds and college endowments are belatedly taking notice. Writes the WSJ: “Public pensions from California to Ohio are backing away from hedge funds because of concerns about high fees and lackluster returns. Those having second thoughts include officials at the largest public pension fund in the U.S., the California Public Employees’ Retirement System, or Calpers. . . . The retreat comes after many pension funds poured money into hedge funds in recent years in hopes of making up huge shortfalls.” What we are seeing is the unwinding of the “stock avoidance syndrome” I highlighted in December 2012. Now that they have doubled, stocks seem safer to asset allocation committees. Go figure.
Krugman belatedly brushes up on bond math. About a month ago he revealed to NYT readers that conservatives hate easy monetary policy because they are greedy. You see, easy money reduces their interest income. As we pointed out, he forgot that declining interest rates boosted bond prices, generating huge capital gains for bond holders, greedy conservatives and enlightened progressives alike. Apparently a colleague took Krugman aside and explained to him that when yields fall, prices rise. Or maybe he read this blog. Anyhow, last Friday Krugman admitted “Yes, low interest rates mean low long-term returns for bondholders (who are generally wealthy), but they also mean short-term capital gains for those same bondholders.” (Emphasis mine.)
French Funk. In the summer of 2012 we highlighted “seven new reasons not to create jobs in France”—specifically, seven tax hikes imposed by President Holland. Since then the over-taxed, over-regulated French economy has slipped from first gear into neutral, even as the conservatively managed economy across the English channel shifted into third gear. Evidently socialism works no better in Paris than Moscow.
Copyright Thomas Doerflinger 2014. All Rights Reserved.
