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Portfolio strategy update Mixed signals David Gottstein
Editor’s note: David Gottstein is with Dynamic Research Group in Anchorage. The stock market has made an impressive advance since its October lows. Corporate earnings up nicely against a quarter and a year ago, a slight up-tick in consumer confidence, an improvement in unemployment claims, advancing productivity and modest economic growth, coupled with an aggressive move by the Federal Reserve in lowering the Fed Funds rate by half a percent to 1&1/4 percent have convinced many that we are on track for an economic recovery.
Where do we go from here? The Republicans are riding high, and add a measure of pro-business momentum. Both the prospect of lower tax rates and the fiscal stimulus brought on by the war against terrorism are already being factored into the stock market.
The question is where do we go from here?
The market certainly has momentum in its favor, along with the aforementioned fundamental factors. However it is no longer cheap.
We peg the price earnings ratio on the S&P 500 at about 18, after giving ample credit for earnings quality. Optimistically assuming the worst is over. Government stimulus key So PE rations might even be higher.
Once again current market price levels are trading at historically high PE’s. Therefore future price gains will have to rely more on earnings gains as opposed to PE expansion.
We believe that the deep rate cut by the Fed reflects their concern about the strength of the economy, and its ability to sustain growth. Consumer demand is wearing thin on mortgage refinancing, as are auto sales propelled by cheap financing.
We believe if it were not for government stimulus brought on by growing deficits, that the economy would indeed be much more likely to be slipping backwards.
When job and demand growth pick up on a measurable basis, we will believe a continuation of the bull market will be justified. Until then we believe it is wise to be cautious. What if wars drags on? It appears that the good news is now priced into the market. The economy will grow, we will win the war quickly, if and when it comes, and things will get back to normal. That means 2-3 percent GDP growth, and 8-10 percent corporate earnings growth.
The problem is what if things don’t go according to plan?
Even though we believe that Saddam’s months are numbered, we believe the terrorist challenge is very broad and deep, and will act as a constant drag on the economy in much the same way that the cold war did.
We are unfortunately going to have to give up the peace dividend. And China will be a constant force limiting future job growth as well. What all this means is that it is likely that the economy will advance very modestly from here.
Until a new paradigm develops.
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