A buying stampede happens when a whole bunch of investors and speculators all decide at once that a market is moving and they have to get aboard, now. We saw something like that recently when despite a poor jobs report, no inflation pressure, Fed waffling on QE2 and other ambivalent news, the stock market started heating up. There are a lot of underinvested or un-invested people who decided this was what they were looking for, proof that the coast was clear to begin investing in this ongoing bull market. Sure stocks are up 70% from the bottom eighteen months ago, but there is a good argument why it should keep going up. The argument goes that the Fed will engineer what looks a lot like stockholder nirvana, lower rates, mild inflation, better growth, a lower dollar and yet not inhibit strong earnings (if you believe that, we’ve got some real estate we’d like to sell you just as soon as the tide goes out.)
This sort of buying panic occurs sooner or later in all bull markets, usually near the end. The trouble with bull markets is that they like to climb this ‘wall of worry.’ So long as we have something to worry about, most of the potential investors will not commit fully to the bull market and so the market has a lot of unspent purchasing power yet to be committed, when the wall of worry breaks down, the flood of money sends stocks much higher. We could be seeing the beginnings of this as cheap stocks meet easy money amid rising earnings.
We have chatted before about our dividend discount model and its output. The DDM has argued for a long time that stocks are just too cheap. The counter argument that stocks are pretty fully valued is based on the assumption that the market has a much higher risk premium built into it now than in the past and that the market does not believe that current interest rates are sustainable. So, if we take two of the four elements in stock valuation and arbitrarily insert values that are not time-tested or related to current market conditions, we can validate the current market price or even come to believe that it is relatively high.
We’re sorry, that’s not the way valuation works. The whole idea of valuation is to compare a known value, today’s price, to a normal situation which we can foresee. Normal doesn’t have an unusually high risk premium attached, nor does it presume a different interest rate environment. Normal takes normal risk premiums into consideration along with the current interest rate environment. We are a long way from normal today, but that is the destination. Valuation is like the map of where we are and it will probably tell us when we arrive.
What is amazing is that we can say something like “the stock market will probably double from today’s levels before this bull market runs its course” and hardly anyone will take us seriously. That is exactly the reaction we want. That tells us that the wall of worry is still largely intact and that we are still able to climb higher with impunity.
Issue of the Week
The election season is in high gear, with candidates all across the country running for office. We will be selecting 36 new governors, this year, 37 senators, and all 435 Representatives to Congress (the opposite of progress). We cannot wait for this whole sordid affair to be over. The timbre of the discussion in advertisements is so downbeat, that we are certain that it alone impinges on the ability of the economy to recover.
How can we possibly manage to function when so many scalawags, scoundrels and malcontents are in charge in Washington? Between the socialists, progressives and liberals on one side who are all about tax and spend and the conservatives and nationalists who are all about saying no to the progressives, there is no path leading to a better future. Has it ever been this bad before? Well, yes, during the Clinton Administration it was about this bad. Nixon had it probably a little worse, and Nixon was not a crook, at least in his own words. Politics in America haven’t been civil in a long time, but at this juncture we could use some civility more than usual. But, we aren’t going to get it.
It seems the 435 crooks in the House probably have the interests of the 10,000 lobbyists firmly in their sights. We will get what is best for the lobbyists and their employers, and if we’re lucky, it won’t hurt the country too much. Why do you think the financial re-regulation bill took 2000 pages? To fit all the special favors and exemptions in there for favored parties. We could say the same for the healthcare overhaul as well. One could write a novel, with character development, plot establishment, a building crisis, a romance, some danger, some humor, and a heroic ending and still have several hundred pages left over. One could write a critique of healthcare as it now exists, with footnotes aplenty, descriptions of problems, solutions, scientific endeavor and all the rest, with hundreds of pages still to be filled. The only reason to write any bill of 2000 pages is to include every lobbyist’s favorite little exemption or wrinkle.
Of course it’s frustrating, but until we derive a better form of government, that doesn’t ultimately collapse into either anarchy or despotism, we’re stuck with this one. Enjoy.
Producer Prices rose 0.4% in September according to the Bureau of Labor Statistics and the core version of the index, which removes volatile energy and food components, rose 0.1%. Energy prices and food prices were boosted by what many think are short-term factors. Over the last 12 months, producer prices have risen 4.0% and the core PPI has risen 1.6%.
Consumer Prices were almost unchanged with gains of only 0.1% in September. The core version of the index without food and fuel was unchanged on the month. The Bureau of Labor Statistics said that in the last 12 months the CPI is up 1.1% and the core up 0.8%.
Importantly, the low level of the CPI in the last year will translate into no increase in Social Security benefits this year, barring some proactive Congressional input. Social Security needs inflation of 2% before benefits are automatically increased.
The US Trade Balance was once again in deficit, the August number was $46.3 billion according to the Commerce Department versus a deficit of $42.6 in July.
Consumer sentiment, the University of Michigan survey, slipped in September to 67.9 from 68.2 in August. The college of economists had guessed that the index would rise, following the Consumer Confidence survey, the Conference Board version, which rose earlier.
Retail sales rose by 0.6% in September after a revised 0.7% gain in August (versus an initial report of 0.4%) according to the Commerce Department. Excluding auto sales, retail sales were up by 0.4%.
We have had another decent week for apparently no good reason. Well, we are starting in on earnings season and it looks to be pretty good this time, again. The earliest earnings numbers have tended to be about what was expected or a little bit better. We suspect that by the time this whole orgy of data is over we will see gains in earnings for the indexes of beyond 15%, probably more like 20% and easily justifying the current price of the market. We are once again frantically looking for better revenue growth that will disappoint anyone who really thinks that is what we need. In fact, all we really need is earnings to justify what we are paying for the stocks. No one will be able to look back at the charts and see that we were really off base waiting for revenues. The bears will rant about revenues being too light until they come up with another reason why we shouldn’t buy this bull market. And that one will be wrong too.
It was a good week for all the indexes, but better for some than others. The Dow lagged pretty badly due to its multiple bank stocks. The foreclosure fiasco caught the banks with their lawyers down. For those not aware of what is going on, the banks hold the mortgages that millions of Americans aren’t paying because their house isn’t worth what the mortgage balance is. Because the folks aren’t paying the bank must ultimately foreclose. Before the bank can foreclose, they have to dot the i’s and cross the t’s in the legal proceeding that is foreclosure. It seems that many of the players aren’t doing a very thorough job and so the foreclosures may not be totally legal. That has been a bigger boon to the non-paying mortgagees than all the moratoria that states and the Federal government have dreamt up. But, sooner or later, the loans will get processed, the homes will be foreclosed and sold and we will finally write the last chapter on the right way to finance the American dream. Hint, it is not with zero down and escalating payments to anyone with a pulse, regardless of income.
Foreign markets had a pretty good show of it last week too. Seems that many of the ‘crises’ of the last few months aren’t going away, but aren’t getting worse either. The basic cyclical drive of the economy appears to be driving the prices higher. Japan seems like the only stick in the mud among developed markets and India plays that role among leading emerging markets, nearly everybody else went up last week.
Bonds were a different story. Treasury bonds slipped last week on disappointing auctions for 10-year and 30-year bonds. The weakness in Treasuries cast a pall over most of the high grade bond sectors, but high yield followed stocks instead. Foreign bond markets were generally weak in the developed world, but mixed in emerging markets.
Real estate securities had a pretty good week with nearly everyone everywhere participating in the bull market.
Commodities were there usual mixed selves with weakness in energy and some ag categories and strength in industrial and precious metals.
Have a great week.
Karl Schroeder, RFC, CSA
Investment Advisor Representative
Schroeder Financial Services, Inc.