The Standard & Poor's 500 Index is up more than 10% in the past month, and it finally looks like all of the thin threads of strength we've seen over the past few months are starting to twine together into a single rope that may be strong enough to pull stocks back up to pre-crisis levels.
The key threads are:
- The ECRI Weekly Leading Index has stabilized and turned higher.
- The U.S. Federal Reserve announced that it had made an epic change in its outlook, targeting deflation instead of inflation.
- Emerging markets and commodities are leading other markets higher, as we have seen for two months.
- Demand for stocks has increased while supply has decreased.
Even if you are skeptical of these developments, remember one thing: The Fed has absolutely flooded the financial system with money.
Banks and large companies have hoarded most of those funds so far, leading gross domestic product (GDP) growth to stall. But the Fed essentially said last week that it is going to double down. The central bank has never had a $1 trillion balance sheet, but it could have a balance sheet twice that size by this time next year if it goes through with its plan.
This money ultimately will be put to productive use, and eventually, it will leak out into the stock market as speculative investment and nurture inflation.
My guess is that any decline from here will be shallow because the central bank has issued what traders are calling a "Bernanke put" – a takeoff on the "Greenspan put" that was believed to underlie the market in the 2000s.
A put is a derivative that swells in value if its underlying instrument goes lower in value. So the idea is that if the economy goes lower, Bernanke's efforts to save it will get larger. This should create a cushion of safety – real or imagined – especially if it is increasingly seen to be "at the money," or triggered by near-term events.
We can mutter about it under our breath and wonder if it's the right thing to do, but it's happening nonetheless. So what I want you to grasp is that the greatest financial bubble in the history of mankind is being formed right in front of our eyes. And the only sensible thing to do is take advantage.
The prospects for the S&P 500 to return to its pre-crisis levels above 1,200 – its level prior to the September 2008 Lehman Brothers Holdings Inc. bankruptcy – are better than ever. In fact, it would not surprise me in the least to see the entire U.S. bear market repealed by the end of 2012. It already has been swept away in many overseas markets, so it's just a matter of time before it happens here.
Skeptics say that the Fed is "pushing on a string" with its plan to flood the system with money because there is not enough demand. But that concern ultimately will vanish as entrepreneurs – enticed by reward and propelled by ambition – will find ways to put the money to work.
It happened in the 1990s, when the Fed flooded the system with money in the wake of the late-1980s savings-and-loan crisis and 1990 recession. Investors were skeptical in the first few years, but the markets ultimately increased five-fold by 2000.
You may recall that period began with the Internet being strictly used by academics and the military, and ended with an incredible boom of the consumer web, which led to billions of dollars in wealth creation and tens of thousands of jobs. However, we are currently in the midst of a commodities bubble that is similar in scale.
Just to get an idea of what I'm talking about consider this anecdote: One of my hosts in Pittsburgh told me about the business of his son-in-law in Lansing, Michigan. The young man graduated from high school a dozen years ago and went to work for his father's tool-and-dye business as an apprentice. Before long he was a master toolmaker and took over the business.
When the recession and credit crisis hit, his local bank was taken over by a larger national bank that decided to pull his line of credit. That would have been fatal to a small company that often had to buy equipment before it could bill for the products that it would create. But the young man didn't fold; he was resilient. He persuaded another local bank to give him credit, and after several lean months discovered that one of his biggest customers, Pratt & Whitney, had won major new bids of its own to supply engines for jets that were sold to Asian and Persian Gulf customers suddenly flush with money from the commodities boom.
That small business is now on track to hire a new employee a month, and expects to be able to more than double its business next year.
So you can see where I'm going: Rise in commodity value = more money for commercial airliners in under-served emerging markets = demand for more engines = demand for more parts = improvement in financial condition of a Michigan manufacturer = more skilled jobs in Lansing = more money to buy houses and cars and spend in restaurants. Several major industrial manufacturers, like The Timken Co. (NYSE: TKR), are already at new highs.
I realize that this may be overly simplistic, but it's real.
Sometimes investing decisions are hard, and sometimes they are not so hard. Right now it's the latter. The Fed sees weakness in the economy and employment, and has vowed to fight them. It has never lost such a battle, though sometimes the effort is prolonged.
More simply, the price/earnings (P/E) multiple for companies in the S&P 500, such as Johnson & Johnson (NYSE: JNJ), is around 13. Given the current level of inflation and interest rates, the average PE of the average large company should be 20-times, and some sober, veteran investors and academics argued over the weekend at a major economics conference organized at Princeton University that it should be 25-times.
This means that prices should be twice as high right now, all other things being equal. That's a bit extreme, but you get the point. All that is missing is a return in confidence – and that should not remain scarce for long.
News and Related Story Links:
- Money Morning:
The Fed's Actions Are Boosting the Bull Cycle for U.S. Stocks - Money Morning:
Leaders Emerging as the U.S. Economy Shakes Off Its Stupor - Money Morning:
What to Expect on Wall Street as Nervous Investors Navigate a Slowing Economic Recovery - Money Morning:
There's Reason to be Pessimistic about the U.S. Economy, but Never Panic - Money Morning:
An Anemic Economic Recovery Keeps the Fed From Focusing on Inflation - Money Morning:
Four Emerging Markets Making Waves Around the World - Money Morning:
Question of the Week: U.S. Federal Reserve Keeping Low Rates Does More Harm Than Good
Good points in the article but the grammar error in tool and dye(it's tool and die) causes me to have doubts about other aspects of the author's research.
I'm probably being picky, but accuracy is everything in stock analysis and information regarding my money.
I disagree on two counts.
1.)That point about the 90's/S&L crisis, it was aggressively falling interest rates and dollar that resusitated the midwestern banks/economy after the commodity bust. Now it's different because interest rates are nearly zero and flooding the system with money (pushing on a string) will not work for us any more than it did for Japan in the 90's and 2000's.
2.)True market bottoms are not found until the P/E on the S&P is below 10. In the 1929-'46 (17yr) bear market, prices fell to meet earnings. In the '65-'82 (17yr)bear market, earnings rose to meet prices (remember the Dow hitting 1000 repeatedly?).
Conclusion: Buy the general stock market when interest rates have topped out ('46,'82) and buy commodities/gold when interest rates bottom out and monitization is the only option ('29,'65,'00). I think we have another seven years to go in gold in this new 17 year bear market. Stay away from the general stock market!!!
Yeah, that spelling thing is hard for urinalists. Oh, wait, that jourmalists.
Marky actually makes a pretty cogent argument here. Not new, but reasonable. It's the Faber thesis. But ask yourself who gets screwed if debts are inflated away? Creditors…read banksters…and the Chinese, Saudi's, Japanese, pension funds, and the rest of the dollar/bond holders. Hmmm. And since the bankers rule the world and control the U.S. government…
If this isn't a bluff and they really do go another Trillion, that amounts to a panic reaction. Maybe you should ask why they're panicking, rather than salivating over stock "gains that will be nothing more than offsets to the dollar depreciation…only you get to pay taxes on them.
Well, I just read about the same story ! True, there is a rule of 20. 20 minus interest rates = the pe multiple that should be applied to the market. This rule seems to have worked since the 1950's . Moreover there is a real possibility that the market will be monetized ? Since the US $ is losing value and is being debased ( It costs less to pay debts ) !
As a trader, I follow some of them and there is one trader who is very strong. He sold all his shipping industry group at the end of 2007 and was not at all in the market until three days ago. Now he is back in but in the metal and mining industry group, with less stocks sure.
In my humble opinion, there is too much fear in normal investors. They have been burned so much that they cannot forget the last drop. And I admit that there are reasons to be afraid, because there is some uncertainty all around. But to the contrary, Technically I have just seen 2 days ago the volatility indexes of Nasdaq, SP 100, Dow Indu, and SP 500 cross down a support line and I guess they should be heading lower, which normally means a higher market. I watch these volatility indexes very closely and act accordingly with y trades. Many markets outside the US are very bullish, the like Indonesia, Thailand, Brazil, Chile, Colombia, South Africa, Turkey and I may forget some. According to a cycle study some say that the US markets should bottom in 2012. For me they already bottomed and I really advise to get in the markets when there is fear and get out when there is complacency. I would also advise to take a look at the five year charts of Dow Indu, SP 500, Nasdaq Composit, and determine which of these indexes are higher than five years ago.
Thank you Jon and company ! I always like to read you.