The most important index of the world, the S&P's 500, sets new records almost daily. Estimates of the S&P 500 earnings per share for 2014 have been projected at $125.02 by Thomson Reuters. With the current traded multiple of 15 we should see 1875 within 12 to 15 months.
Some folks, however, say enough is enough. I hear a lot of (day) traders moaning and groaning about the lack of volatility and the slow but steady climbing stock prices. The temptation to sell this market grows by the hour, but what could be a reason for shorting this sneak rally?
I asked around and heard the following reasons:
-Disconnection stocks and economy
-Fear of heights
All western nations are loaded with debt. Once interest rates are rising and returning to pre-crisis levels, the interest payments for countries such as France, Spain and Italy and also the U.S. will be unbearable.
Disconnect between stock prices and real economy:
It's just impossible that in times of economic crisis stocks keep going up. There is a disconnect between the real economy and stock valuation which can only last for a short while. Since the current economic situation seems to worsen instead of improve, markets should come down within reasonable time. Sluggish job growth in the U.S. and the latest German economic figures seem to confirm this theorem.
Fear of heights:
People look at the market and don't recognize the prices we're currently trading at. It's just too high they say, and they want prices to go back to "normal."
Investors don't trust the markets. Stock prices have been pushed up with cheap money and lack support of company earnings. What if the Fed stops easing, and stocks have to do it on their own?
All these reasons sound valid and true. But looking at the reasons for investing in the first place, investors are seeking to:
- Protect their wealth
- Expand their wealth through a decent return
This is where the fundamentals of this ongoing rally are built on. Now, since the Lehman collapse, investors have mainly been focusing on protecting their wealth. It explains the huge surge in gold prices, commodities and especially treasury bonds. However, when economic activity picked up again in the US and emerging markets, the focus from investors shifted from protection towards expanding wealth. To expand wealth we need to beat inflation. With an inflation level of around 2%, investors need to target higher yields than the ones they receive on a savings account. Treasuries: same story. Commodities don't yield at all and gold already seems to be on its way back. So: what's left?
The only thing left is stocks. Stocks with dividends and a reliable track record, like 3M (NYSE:MMM), McDonald's (NYSE:MCD) and Exxon Mobil (NYSE:XOM). In my article of April 11th, about the TINA-effect, I described why there is no alternative for stocks these days:
1. Stocks are a hedge for inflation. When producer prices go up, companies usually pass it on to customers.
2. Dividend yields of 3% are quite normal for decent S&P 500 companies.
3. Most companies have cut costs and their workforce already at the start of the financial crisis and are "lean and mean" at the moment.
5. The economic environment is very favorable for stocks: slow growth means cheaper labor and low interest rates for a considerable longer period.
6. The Bernanke Put. The Fed, and with it other central banks, are safeguarding the economy. For stocks, a win-win situation. When it gets worse, the Fed jumps in. When it gets better, profits will soar because of excellent cost control.
In fact, there are several reasons why the stock market isn't as expensive as people think: S&P earnings per share for 2013 are estimated at $113 by Thomson Reuters. For 2014, earnings per share are projected at $125.02. A multiple of 15 shouldn't be regarded as very unusual considering the above mentioned circumstances.
Therefore, the S&P 500 could climb up to $1875 by 2014 quite easily. The big rotation out of gold and treasuries is just underway. The only thing we don't need right now is another economic disaster. Luckily we've got somebody monitoring our financial system: his name is Helicopter Ben. He's the best friend Mr. Market has had for decades.