All Signs Point to an Upcoming Bull Market

The perfect storm is brewing on Wall Street right now:

● 8 of 10 all time largest corporate buyouts occurred recently

● Private equity is sitting on nearly $1 trillion in cash (about 1/10 the value of the S&P)

● Stock buybacks are averaging $2.4 billion daily while corporate selling (new offerings & insider selling) is around $900 million daily.

● The yield on the 10-yr treasury is 4.8%

● According to S&P the dividend + buyback yield = 5.6%

● The earnings yield on the S&P 500 = nearly 8% (2007 estimates)

● Earnings season is over and companies beat estimates by a ratio of 4:1

● Earnings estimates are rising

● Currently the fourth consecutive month of US equity fund outflows (last time was late 2002)

● The yield curve is inverted

Ok, so the yield curve is inverted, I know that has historically signaled a recession. But what does an inverted yield curve really mean? It means long term inflation is under control and short rates will be moving lower in the future. Most corporate debt is financed on the long end, so the fact that yields are falling is allowing companies to issue debt at lower yields and lower their cost of capital.

The average investor is clearly bearish as witnessed by the fourth month of US equity fund outflow, but corporate America clearly isn't as witnessed by the record buybacks and M&A activity. The amount of cash just looking to be put to use is mind boggling, and when that happens it will be seeking the highest returns as capital always does, with stocks looking more attractive on a dividend/buyback & earnings yield basis. Lets not forget the analysts who follow these companies full time, they are currently revising their earnings estimates upward further showing that the fair value of many companies is above current levels.

Ok, so you say with all this cash being put to use, when it finally happens there will be massive inflation. Let's not forget that businesses are growing and they need capital to finance this growth, perhaps why the yield curve is signaling low inflation ahead. So we have growth with little inflation, sounds like the making of a bull market.

Comments

[Mike Hammar:]

Everything I have seen says that earnings estimates are coming down. Where did you see that companies are raising estimates?

2006 Aug 31 12:01 AM

[Donald Last:]

Can we call large buyouts a lead indicator? May simply reflect recent good growth and masses of corporate cash lying around.
The yield gap between 10yr TB and the S&P earnings yield has been with us for some years so nothing new there. Maybe companies did beat estimates by 4:1 but markets try to discount what might be coming up and past achievments are soon forgotten.
Yes, yield curve inversion signalling a recession could be old hat because long yields have been strangely sticky for a long time now - Bernanke's global savings glut with some of the excess going into Treasuries?
Equity outflows? Yes, a contrarian argument that the crowd always gets it wrong.
Adding it all up, however, does not seem to make for a bull rush since we have not seen yet the outcome of the downturn in housing. It is just beginning. And as another article on today's page points out, business investment is getting tired.
The basic fact about a bubble, or a period of extreme price movements, is that the factors that gave it impetus when the market turns begin to reverse and compound the fall. Also, a bursting bubble always, but always, reveals crimes and misdemeanours.

Donald Last

2006 Aug 31 01:51 AM

[Barry Gitarts:]

Analysts are raising their estimates

2006 Aug 31 09:47 AM