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Fundamentals Make Me Bullish, Though It Still Feels Strange

The never ending bull market has forced me to rethink my assumptions about GDP, earnings growth, inflation, and valuation. Bottom line, I remain bullish on stocks and I'm a buyer on weakness.

Below are my thoughts, followed by some research I liked this week.

  1. GDP: No change to my the New Normal assumption of 2% GDP growth.
  2. Earnings: I expect earnings growth of 10% in 2014, just below consensus of 10.8%. Productivity growth and sustained high corporate margins surprised investors for the last half of the 1990s, and recent experience is similar.
  3. Inflation: Most of us have been wrong for the last four years, waiting for QE and ZIRP to cause inflation. It's time to admit we're wrong. Private deleveraging by banks and a slump in monetary velocity have squashed inflation. What if it is ANOTHER four years before we see inflation? I think that the burden of proof has shifted from the doves to the hawks.
  4. Valuation: The market is fairly valued at 15x forward EPS of $120 for the S&P 500. As long as earnings hold up, this market will not collapse due to an uptick of inflation, or a "tapering of the taper."

Here are some of the links I liked this week.

Equity Valuations

The latest corporate earnings from FactSet has analysis suggesting that the S&P 500 is not overvalued based on forward 12-month earnings. The S&P 500 recorded roughly 3% earnings growth in 3Q, and despite negative guidance for Q4, consensus calls for 10.8% growth in 2014.

GMO recently offered an in-depth look at the relationship of ROE to equity returns, and it's worth a read.

Dividend Boom

FactSet's dividend quarterly shows a skyrocketing rate of dividend growth by any measure: payout ratios, aggregate payouts ($329 billion over last year ending 9/30/13), % of firms paying dividends, % increasing dividends.

Corporate Margins Are the Spoiler

Doug Kass, a well-informed dedicated short investor, believes that record corporate margins are the fatal flaw in today's bull market.

Shrinking Bond Liquidity

Here is a depressing report about bond funds and ETFs from Matt King, credit strategist at Citi. High-yield assets have exploded in recent years while dealer inventory has shrunk. It's a big trade with a small exit, and that's not where you want to be when a Minsky moment arrives.

Holding Bonds in a Rising Rate Environment

Recent research from PIMCO argues for continued use of bonds as a portfolio diversifier, and discusses tactical and strategic ways to address a secular rise in rates.

Muni Flight

Munis see 25 straight weeks of net redemptions, as Lipper notes here (7th paragraph). 74 straight weeks of inflows into floating rate notes.