Market in General
The broad market ended March at about the same place as where it began. Concerns over turmoil in the Middle East were further exacerbated by the earthquake and terrible tsunami in Japan, then capped by fears related to Japan’s nuclear facilities. The end of the month did see a recovery in investor sentiment as the shock of these events faded. The volatility we’ve seen the past few weeks has underscored the nervousness many investors still feel as an aftereffect of the recent recession. Historically low interest rates, low inflation, strong earnings, cash heavy corporate balance sheets, and business friendly Fed policy have all contributed to a resilient market. History has shown that stock prices follow earnings. Earnings are increasing, so the market keeps rising – no matter what non-business news may cause temporary volatility on any given day.
Leon Cooperman, chairman and CEO of Omega Advisors and Wall Street veteran with 45 years of experience, recently gave an interesting interview to CNBC that addressed value and volatility in the current market.1 He noted that the historical P/E ratio for the market is about 15, that inflation usually runs at 3% or greater, and average 10-year Treasury yield are at 6.00%. Currently the S&P 500 has a P/E ratio of 13.4 (based on the next 4 quarter’s earnings), inflation is between 1-2%, and 10-year Treasury yields are 3.48%. This combination of data points shows him a market that still has room to rise and is more attractive for investors than either bonds or cash. While news of world events does cause volatility in markets, Mr. Cooperman notes that the U.S. stock market retains value and keeps growing over the long-term. An interview with Bill Miller of Legg Mason Capital Management reminded investors that the current P/E ratio of the market is only slightly above that of the P/E at its low in March 2009.2 This means investors are paying about the same now as they were back when the market was at a low.
As of March 23rd, CNBC notes3:
The blended earnings growth rate for the S&P 500 for Q4 2010, combining actual numbers for companies that have reported, and estimates for companies yet to report is currently at 37.1%. As of October 1st, the earnings growth rate was at 31%. Of the 496 (99%) S&P 500 companies who have reported Q4, 70% beat estimates, and 21% were below estimates. The estimated earnings growth rate for the S&P 500 for Q1 2011 is currently at 13.7%. (Data provided by Thomson Reuters)
The bottom line is that companies are not only making money, they are increasing profits and exceeding expectations. The growth we have seen in the stock market reflects this situation.
Manufacturing
The Institute for Supply Management’s (ISMs) release of March figures4 notes an index figure of 61.2. A year ago this index stood at 57.8 and the 12 month average has been 57.9. A reading above 50 indicates that the economy is expanding. The 12 month figures for this index show an economy that has not only been expanding over the last year, but that has picked up the pace of growth significantly over the past 6 months. There are some areas of concern due to increases in commodities prices and a drop in new orders for export within the report, but overall new orders continued a 21 month trend of increase, production is up, and inventories are down. This increase in activity has also led to increased hiring for the 18th consecutive month within the manufacturing sector.
One area within manufacturing worth extra scrutiny is vehicle sales. Recent reports show U.S. auto sales continuing to rise. GM noted a rise of 9.6% on sales when comparing March 2011 to March 2010.5 First quarter sales were up by 24.1% over the first quarter of 2010. Ford also released solid increases of 19.2% for March 2011 compared to March 2010 and an increase of 15.9% for the quarter over last year’s first quarter.6 Big ticket items like this are good indicators of movement in the economy. Consumers and businesses are not willing to pay thousands of dollars for a new car if they are worried about future income prospects. The rebound in sales of this sector is a good indicator of increased stability amongst both consumers and businesses.
Unemployment
Unemployment is down. In fact, it now stands at its lowest level in 2 years, with a positive outlook as many large companies are noting plans to add jobs. A March survey of CEOs found Google, Siemens, Ford Motor Co., and many others with plans to add workers.7 The addition of 216,000 jobs last month has brought the unemployment rate down to 8.8%. Gains have occurred in professional and technical services, mining, manufacturing, health care, leisure and hospitality, factories, and the temporary help sectors. These gains have offset the losses in government jobs, construction, and telecommunications that were reported. Payroll has grown by 1.5 million jobs since the low of February 2010.8
Economists expect a net gain of 2.5 million jobs for 2011.We do need to see an average of at least 300,000 new jobs a month in order for unemployment to lower significantly.7 There is still cause for concern in this sector as the number of people either working or actively seeking a job is still unexpectedly low and about half of those unemployed have been out of work for 27 weeks or longer. However, the fact that the unemployment rate has dropped by a full percentage point over the previous four months is truly good news.
Housing
The housing sector continues to perform poorly. The national vacancy rate stands at 11.4%9, unemployment and uncertainty are keeping some otherwise potential buyers out of the market, and prices continue to fall in many markets. The national median-existing home price was $156,100 in February. The median new home price was $202,100 for this same month. That is quite a difference and is historically quite high.10 In fact, this premium is double its 2000-2006 average.11 Homebuilders are simply not competitively pricing their inventory in the current market. This situation will eventually stabilize. The lack of new home construction coupled with pent up demand will coincide to stabilize the housing market. When exactly this will happen is a guessing game though.
Inflation
I periodically hear from clients with concerns over inflation. They often recall the 1970’s and the hardships faced by many at that time. While most people recall this inflationary period being driven by higher energy costs, that is really only a portion of the full picture. A significant portion of the inflation we saw then was driven by rising wages and rising real estate prices, two factors that are noticeably absent from today’s economy. Wages are about 70% of the cost structure for most corporations. Workers often saw annual cost of living increases of around 9% over multiple years in the late 1970’s. Wages are currently growing at an average of just 1.7%8, a far cry from the 9% seen in the past! An excess of workers in the current economy, coupled with a soft housing market provide a buffer against rising gas and grocery prices.
It is also important to note that the nature of the U.S. economy has changed since the 1970’s. The economy was much more industrial in nature in the past. This meant increases in energy prices were felt in large key sectors and passed along through the rest of the economy. Our current economy has a much smaller industrial sector and much greater health care and technology sectors. These newer sectors do not feel the effects of rising gas prices to anywhere near the same degree as industrial sectors did in the 70’s. While rising gas and grocery prices are of concern and do merit watching, this rise is not occurring in the same context as the rising gas prices of the 1970’s.
Summary
The economy is slowly, but steadily, recovering. Corporate profits are increasing. Unemployment is declining. While there are always world events and sectors of the economy to worry about, the U.S. economy as a whole is growing and doing well. It could be doing better and there are long-term issues that need to be addressed in order to continue the growth pattern we have seen leading away from the recession, but the bottom line truly is that the U.S. economy is alright. Stocks are a good investment. They trading at historically low P/E ratios while Treasuries are paying historically low rates. We will likely continue to see volatility in the markets as shaken investors react with emotion to whatever bad news comes next week, the week after, and the week after that. Seasoned investors will continue to look at profits, estimated earnings, and data regarding the economy as a whole as they continue to look for value and growth within their portfolios.
1) http://classic.cnbc.com/id/15840232?video=3000011991&play=1
2) http://www.cnbc.com/id/42235267/Market_Is_20_Undervalued_Legg_Mason_s_Bill_Miller
3) http://www.cnbc.com/id/15839135
4) http://www.ism.ws/ISMReport/MfgROB.cfm
5) Fidelty.com, MarketWatch, 10:52 am 4/1/2011
6) Fidelty.com, MarketWatch, 12:07 pm 4/1/2011
7) http://seattletimes.nwsource.com/html/businesstechnology/2014654816_apuseconomy.html
8) http://www.bls.gov/news.release/empsit.nr0.htm
9) http://money.cnn.com/2011/03/28/real_estate/us_housing_vacancy_rates/index.htm
10) http://www.marketwatch.com/story/sales-of-new-us-homes-tumble-169-to-record-low-2011-03-23?dist=afterbell
11) briefing.com, Economic View, 4/1/2011
The information contained in this newsletter is for general use, and while we believe all information to be reliable and accurate, it is important to remember individual situations may be entirely different. The information provided is not written or intended as tax or legal advice and may not be relied upon for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a solicitation of the purchase or sale of any securities.