Over the past 3½ years markets crawled higher, we have
watched the gradual but steady build up of bullish expectations. You can see it
most plainly in the 2006 BusinessWeek forecasts. The majority of strategists,
technicians and economists are expecting gains for the markets in 2006, ranging
from mid-single digits up to as high as 30%.
In the Fall of 2002, you were hard pressed to find such
sentiment. As telecom stocks bottomed, and profitable technology stocks sold
for less than cash on hand, the Bulls were MIA. Telecom, tech and internet
stocks, having so duplicitously betrayed their lovers, were widely despised.
It wasn’t only the sentiment that was different back then:
Nearly every metric we track was in a different part of the cycle, and pointing
in a different direction. Both the vector and angular momentum were different
than at present. Consider each of the following:
Interest Rates: In 2002, bond yields were low and heading
lower. Since then, bonds have worked their way lower sending yields considerably
higher – and they’re heading even higher still; (See nearby Yield Curve charts);
Inflation: The Fed reflated the economy, but awoke
inflation. 3 years ago, prices were stable; the big fear was deflation. Today,
prices for goods and services are rising.
Earnings Growth: Year-over-Year earnings were awful in 2002, with easy comparisons, and
nowhere to go but up. Today, with comparisons much harder, earnings growth is a
the top of its range, and is more likely to decelerate;
Fiscal Policy: The Deficit was modest; Federal taxes,
especially those on dividends and capital gains, were being cut. Today, rates are more likely to rise than
drop. Taxes at the State and local level have been creeping higher;
Real Estate: was beginning a historic growth spurt with
major economic impacts: it created 42% of new private sector jobs, allowed
mortgage equity extraction of $2 trillion dollars, and drove massive consumer
spending – and GDP. Today, at best RE is cooling down; At worst . . .
Consumer Debt: was problematic, but manageable. Now, the
negative savings rate combined with significant increases in mortgage debt are
Commodities: Oil was
under $30 and exerted little drag on consumer spending or transport costs;
Industrial Metals were cheap, Gold and Silver were half their present
The macro environment, despite the negative sentiment – or more accurately, in large part, because of it – was far
more attractive three years ago than it is today.
Note: This was part of a larger research piece that was emailed to institutional clients on April 11, 2006 at ~10:00am