Rabbitt Analytics Newsletter Q-Market Strategy (Volume 7.07)
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Paul Rabbitt RabbittAnalytics .com |
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Stocks are more attractive than cash or US treasuries. Small to mid-cap US stocks should be over weighted. In the long run, global emerging market stocks are more attractive than domestic issues. US equity markets have begun a sustainable, bullish trend. Powered by global economic recovery and sustainable corporate earnings growth, stocks should now rise for several years.
The world economic recession has transitioned into economic recovery. A short-term recovery bounce of between three and four percent is not improbable over the next two or three quarters. Then, after settling down, the US economy should be able to deliver a sustainable 2-3% growth rate for the next few years.
Shepherding Your Capital
Some may argue that, until the S&P breaks above 1125, the long-term down trend of the last few years has still not been broken. We disagree and believe the bull market started off the lows in March.
During the two years of the bear market, there were five rallies that ranged between 10 and 20% that ultimately resulted in failure and lower lows. Because of the existence of these "bear traps", it would have been unwise to attempt to call the March low. The risk of it being just another bear market rally was too high. However, during the months of May and June, the market rose against the backdrop of the bankruptcies of General Motors and Chrysler. This signaled a character change in the market, as it was the first time stocks had risen on bad news - a classic sign of a bull market.
When stocks managed to go to new highs for the year, breaking above the old January highs in mid-July, the reliability of the trend became much stronger. Technically, it was now significantly safer to re-enter the equity markets.
This Is What We Know (Certainties):
1. Real Estate - U.S. mortgage applications jumped in late September. The Mortgage Bankers Association said its seasonally adjusted index of mortgage applications has risen to the highest level since May, an early indicator of appetite for new home purchases.
2. World Economic Growth has turned positive, led by Asian countries. There is little reason to fear the economy cannot sustain its recovery. The Leading Economic Indicators has shown four straight monthly increases. Fed Chairman Bernanke has declared that the recession is over. The Fed is likely to retain a 0% Fed funds rate until late 2010. The Fed met in late September and continued to gradually withdraw some of the stimulus deployed in the past year. For example, the Fed opted in August to taper down the Treasury purchases by the end of October, and in its meeting in late September, stated it would begin a similar gradual withdrawal for its mortgage debt buying. Much of the US stimulus plan is still held in reserve and has not had an effect on economic recovery. To date, less than 40% of the approved stimulus plan capital has been deployed.
3. Job growth continues to be dismal. We don't expect an improvement in the jobs until the second half of 2010. However, jobs are a lagging indicator of the economy.
4. The Dollar is down 15% since '08 and is likely to firm up, reflecting economic recovery in the US.
5. The ISM manufacturing index reflects currently that this sector has returned to a growth phase. Industrial production jumped 1% in July and again .8% in August, supporting optimism about a recovery.
6. Global Capital Flows - will seek the growth of the BRIC (Brazil, Russia, India, China) and the safe haven provided by the US.
7. Commodities are mixed. Energy has backtracked after a global supply glut has been revealed. Agricultural commodities have been very weak.
8. Inflation is expected to be 1.5% in 2009. The CPI is actually down 1.5% in the past 12 months. We expect inflation to be very low for the next several years. While industrial commodities and gold have shown some strength, agricultural commodities have plunged. Wage inflation is expected to be nonexistent for the next several years. While US labor will always receive a premium level of income because of their training and quality, we expect US labor force compensation levels to be somewhat recalibrated to the world labor force. Moreover, manufacturers have barely managed to work down the inventories that had accumulated during the recession. The economic recovery should be relatively tame as governments seek to rebuild their balance sheets, which have weakened due to stimulus package borrowings. This will dampen the recovery and demand. Manufacturers will not have robust pricing power.
9. Consumer Sentiment - rising stock equity and home prices will stimulate consumer spending. Retail sales have been surprisingly strong, supported, in part, by the "cash-for-clunkers" program. Consumer confidence has improved, reflecting a more upbeat consumer attitude.
10. Stock valuations are in the normal range. Massive sideline cash and extremely low interest rates suggest stock price / earnings ratios should expand over the next several years. Investor focus will switch to earnings growth as the economy begins to recover.
11. Double-digit profit-growth for the Standard & Poor's 500 is projected in 2010. Still, most analysts remain very pessimistic with their earnings forecasts. If price / earnings ratios remain constant, investors should expect 10% or better gains in their stocks in 2010. The S&P 500 PE ratio is at approximately 15x estimated 2010 earnings.
12. Cyclical forces are favorable. The four-year presidential election cycle reflects strong tendencies for economies to enter recessions during the first year of the presidential four-year term and gradually recover through the rest of the term. The US economy is on the way towards reflecting a normal presidential four-year cycle.
Risks, Double Dip Recession, Deficits, and Protectionism
Some prognosticators project a double-dip recession will occur, reflecting the failure of the stimulus packages deployed worldwide. We believe all governments and central banks around the world are "on-point ", meaning they are hypersensitive to a pullback in their economies and stand ready to provide liquidity to avert any such occurrence.
The US bailout will result in the federal government facing huge budget deficits for years to come. We believe that deficits were a necessary byproduct of creating liquidity, which successfully averted an economic depression. Investors have reflected valid concerns that the payback may result in persistent inflation, high taxes, or foreign refusal to continue purchases of our debt securities. These concerns are a good first step towards creating the political will to resolve our budget deficits in future years.
A recent tariff increase on Chinese tire exports to the US has caused some saber-ratting from China. We are monitoring creeping protectionist policies, which could result in repercussive "trade-wars". We believe the risk is minimal of this occurring.
Paul Rabbitt is an independent research analyst and portfolio manager. He is CEO of Rabbitt Capital, and chief portfolio manager of hedged and private capital. He is President RabbittAnalytics.com, delivering independent stock research to private and institutional clients since 1998 featuring the "Q" Stock Ranking system, a twelve-factor stock risk/return model ranking 2500 stocks daily, since 1989, with one of Wall Street’s best published track records.
Paul previously held dual roles as both Senior Portfolio Strategist and Chief Quantitative Analyst at CIBC Oppenheimer where he was an employee and partner for twenty years.
Institutional Investor Magazine has ranked Paul among the top eight quantitative strategists. He is a frequent commentator in the national and international media.