The way I see it, most investors fall into one of two buckets: One is toe-in-the-water bullish (which is to say, lukewarm), and the other is bearish, or otherwise looking for a serious pullback before putting money to work in the stock market.
I'm betting both buckets are wrong.
While I won't be doing another Top-10 list this year (though it is tempting, as the opportunities are as robust as ever), if I did, I would reprise my market call from December 2012: "The market is going higher, maybe a lot higher." And its for the same reason: until we get broad-based enthusiasm for stocks, evidenced by things like a robust and frothy IPO calendar, and maybe several years of inflows into equity mutual funds, you've got to bet this market is going higher, probably a lot higher.
For one thing, nobody is looking for it. The bears continue to be irrational on things like the debt issue (more on that below), while namby pamby bulls are looking for modest upside. What if both crowds are wrong - as they have been so far in 2013 - where does that leave us? Let me suggest: it leaves us with risk to the upside, not to the downside. The surprise, if there is one, will be that the stock market puts on quite a show between now and the end of 2014, perhaps something like a 20%-30% move higher, maybe more.
How is that possible, given current stock prices? Expansion of PE ratios would accomplish most it. It's easy to imagine PEs moving to 18 from about 15, given that the runway for economic growth stretches to 2020 and beyond. There is no bottleneck of any sort. Labor is plentiful, capacity is ample, demand is pent up. Earnings will continue to surprise, primarily because corporate expenses were pruned dramatically during the credit crisis. Lean and mean, meet increasing revenue. Profit to follow.
At the corporate level, the decline in interest rates has been a windfall. I mean, which corporation hasn't taken advantage of lower interest rates? For example, MGM, one of my Top-10 picks for 2013, recently refinanced its debt and it will save $230 million in interest expense in 2014. (Take note, investors, this is not yet factored into earnings estimates.)
Rick Santelli and the CNBC indicator
Business Week is forever remembered for proclaiming "The Death Of Equities" on its cover at the beginning of the 1982-2000 secular bull market. Now that print media are no longer a leading force, I submit: As a contrary indicator, CNBC appears to be a terrific replacement. It established itself as such in the late 90s. Remember the Maria Bartiromo-led fanfare as the Nasdaq blew past 3,000, and then 4,000, on its way to 5,000? Cheerleading on CNBC presaged a nine-year bear market, the worst since the Great Depression.
If rampant enthusiasm on CNBC should've scared investors in 1998 and 1999, how should investors react to the last few years of fear mongering by scare-bear Rick Santelli, ably assisted by Joe Kernan? Santelli, as I'm sure you know, has led a rant-infested campaign against America's debt. Here he is at the beginning of 2013, saying "you need to be a man when looking at debt," and calling those who disagree, "childish" and "lunatics."
Ahem. Yes, well, now to the facts. This is a chart from the St. Louis Fed, which shows how much we are currently paying to service debt. The chart is updated as of August 2, 2013. Given recent growth in tax receipts, there's a good chance debt service will soon approach levels not seen since the 1960s.
As you can see, there is no disaster lurking. And it's not even close: Look at the '80s and '90s, when debt cost was more than twice as much as it is now, hovering around 3% of GDP (meanwhile, stocks were generating 14.5% annual returns).
Of course, scare-bears will take one look at the chart above and say, yeah, well, wait until interest rates go up. But it's a weak argument, and speculative, too. Indeed, economic growth may drive rates higher, but it'll be counterbalanced by higher tax revenue (as we've already seen this year). And it's speculative because there are substantial deflationary forces at work - we've got excess capacity across the board, and, at the same time, technology (e.g., automation and robotics) is exerting powerful deflationary pressure. It's far from a guarantee that interest rates are headed appreciably higher, even with a robust economy.
To my fellow lunatics, this is the fair and balanced way to view debt: it's called a balance sheet. American households are liable for $16.4 trillion in debt, and, yes, we're good for it. (It's not like we need to write a check, for goodness sakes, it's interest-only debt because it gets rolled over.) On the left side of the balance sheet: net household assets exceed $70 trillion, that's up $3 trillion in the first quarter alone. And I'm not counting the government's massive asset base, which includes vast real estate holdings.
The bottom line: Our balance sheet is strong and getting stronger, catalyzed by growth in housing, an emerging energy boom, and amazing advances in technology. Investors should take scare-bears for what they are, a terrific contrary indicator. America is getting its mojo back, and the sooner investors recognize it, the better.
(Lunatics, go here if you're looking for stock ideas.)