US Stock Market Update
March 18, 2012
David R. Kotok
1404 is a new recovery high on the S&P 500 Index. The last time we saw that number it was on the way down. That reference S&P 500 index hit a low of 666 following the Lehman-AIG collapse and in a massive selling climax at the end of the waterfall decline.
This time 1404 is on the way up, after a selling climax on October 3, 2011. That climax is clearly confirmed. So now what? “Inquiring minds want to know.”
1. A gaggle of terrified investors has watched a huge stock market recovery, starting with the March low in 2009. The S&P 500 Index has now more than doubled. Cacophonous pundits were predicting the end of the world during this period. Some of them are still doing so.
2. Meanwhile, the central banks of the world have addressed the crisis with unpredicted and unprecedented liquidity creation. Over $4 trillion in excess reserves now sit on deposit at the G4 central banks (as dollars, euros, pounds, and yen). History offers no guidance on policy magnitude like this.
3. Excess liquidity has driven worldwide interest rates toward zero in the short term and to 1%-2% in the intermediate term. That global central bank policy-driven result is unlikely to change in 2012 and may extend into 2013 or even 2014. No one knows how or when it will change or end. The present trend is more global liquidity, not less. This impacts about 85-90 percent of the capital markets of the world.
4. Financial assets rise in price when they are in continuous competition with a persistent level of zero interest rates. They look better than cash even as they rise in price (decline in yield). When compared with zero, the proportional increase in yield is always relatively inviting. Moreover, it is fear-inspiring, because investors know that it cannot last forever.
5. The global community of investors does not know what to do now. They know this cannot go on forever. They do not know when it will change. They worry about what will happen when it does change. That worry restrains them. Then they watch stock prices rise and they have angst because they are on the sidelines. Think about it: a fund manager who is not invested has to send a report out at of the end of a quarter and explain why he missed a bull-market move that carried prices up with great strength. Alternatively, he has to get into the market, whether he likes it or not. The pressure on sidelined cash is enormous.
We are worried like everyone else. The recent oil price shock and the resultant demand destruction are showing some early signs of extended durability. IF THAT CONTINUES, it could soften the outlook for the US and other mature economies.
Europe has been temporarily calmed, but the issues have not been fixed. Huge liquidity is a salve. It treats a symptom. It does not cure a disease. It does not solve issues of insolvency like Greece or European banks with insufficient capital.
In the beginning of March we raised some cash for a few days. We quickly reallocated that and are fully invested as this is written. We continue to overweight financials and energy. These and other positions could change at any time. The S&P 500 Index is above our earlier target for the end of the year. Our best guess is that S&P earnings this year will be between $100 and $105. That makes a 1400 level reasonable.
However, those earnings are coming out of a very large profit share of the GDP. They are coming at the expense of the labor share, which is languishing but showing some early signs of recovery. We do not know how long this condition will last. It may be many years or it may start to normalize sooner.
We leave for Paris on Tuesday. There are two days of serious meetings on risk, followed by the GIC conference at the Banque de France next week. See www.interdependence.org for the conference line-up. We will be meeting in the magnificent La Galerie Doree, Banque de France. There may be a few remaining empty seats for any last-minute folks who sign up. Call GIC for details. (215) 238-0990.
David R. Kotok, Chairman and Chief Investment Officer