Opinion: The equity bull market can last up to five years – here are six reasons why
When the stock market sells, as it did on Thursday, the right decision was to buy your favorite stocks. Friday’s market action proved it.
It is true that there could be a correction, given the already large 17% gain in the S&P 500 SPX index,
this year. But you should buy then too.
We’re still in the early stages of what will be a three- to five-year equity bull market, for these six reasons.
1. There is a huge pent-up demand
Everyone is looking to the Federal Reserve for clues about the stimulus. They overlook the private sector forces that will push stocks higher. To sum up, there is a huge pent-up demand from the private sector that will help propel US GDP growth to 8% this year and 3.5% to 4.5% for years to come. The pent-up demand comes from the following sources, points out Jim Paulsen, chief strategist and economist at the Leuthold Group.
First, there has been an increase in household formation as millennials have reached family years. This helps to explain the sharp rise in demand for housing. Once you buy a house, you have to fill it with things. More consumer demand on the way.
Behind the scenes, consumers have huge unspent savings because they looked at the pandemic. The personal savings rate reached nearly 16% of GDP, against a post-war average of 6.5%. The previous peak was 10% in the 1970s.
At the same time, household balance sheets have improved remarkably. Debt-to-income ratios are the lowest since the 1990s. Consumers will continue to seek more bank loans and credit cards as their confidence increases as jobs and the economy remain strong.
Then there will be many more new hires once the extra unemployment benefits expire in September. This means that consumer confidence will improve, which invariably stimulates economic growth. The labor force participation rate may improve, leaving employment capacity unused before reaching full employment which can cap economic growth.
Now let’s look at pent-up demand in business.
Do you know all the product shortages that you come across or hear about? Here is why this is happening. To prepare for a protracted epidemic, companies have cut inventory to the bone. It was the largest inventory clearance ever. But now companies need to replenish their stocks. The ongoing replenishment of stocks will be enormous.
Companies have also reduced their capacities, which they are in the process of rebuilding. Spending on capital goods has reached record highs in the past year, rising nearly 23%, after being essentially flat for most of the previous two decades. This creates sustained growth and tells us a lot about business confidence.
The bottom line: We will see 7-8% GDP growth this year, followed by 4-4.5% next year and above-average growth thereafter, supporting a sustained bull market in equities. Expect normal corrections along the way.
2. An underestimated earnings boom looms
The economic rebound has happened so quickly that analysts cannot keep up. Wall Street analysts are forecasting $ 190 per share in S&P 500 earnings this year. But that’s woefully low given the expected GDP growth of 7% to 8% and the massive stimulus that has yet to be launched. The relaunch normally takes six to eight months to take effect, and much of the recent spoonfuls have occurred within that window.
Paulsen expects the S&P 500 earnings in 2021 to come closer to $ 220 instead of the consensus estimate of $ 190.
“Analysts always underestimate how much earnings have improved and how much they will improve,” Paulsen said. “We have had a dramatic overreaction from politicians. They approached the collapse, but created a massive improvement in fundamentals. This is still playing out in terms of profit recovery. “
In addition, further fiscal stimulus is likely underway, in the form of infrastructure spending.
3. There’s a new Fed in town
For much of the past three decades, the Fed was quick to tighten policy to avoid inflation. The central bank killed growth in the process. This is one of the reasons why the past 20 years have shown the slowest post-war growth. Now, however, the Fed is much more accommodating and that could likely persist as inflation will remain subdued (more on that below).
Here is a simple gauge to measure that. Take the GDP growth and subtract the yield on 10-year treasury bills TMUBMUSD10Y,
This gauge was negative for much of 1980 to 2010, when the Fed kept growth cool to contain inflation. Today, however, the Fed’s policy is helping to keep 10-year yields well below GDP growth, allowing the economy to run at full capacity. This was the situation of the years 1950-1965, which some analysts call “the golden age of capitalism” because of the downward trajectory of growth.
4. Inflation won’t kill the bull
Inflation can rise in the short term because the economy is so hot. But in the medium term, the inflation killers will win out. Here is an overview. The population is aging and the elderly are spending less. Booming business capital spending will continue to boost business productivity. This allows them to avoid passing the increased costs on to customers. Global trade and competition have not gone away. This puts downward pressure on prices, as goods can be inexpensively manufactured in many foreign countries. Continuous technological advancements continually exert downward pressure on technological products.
5. Valuations will improve
We are now in the economic rebound phase where the following dynamic generally unfolds. Stocks trade sideways for months, mostly because of concerns about inflation and rising bond yields. All the while, the economy and earnings continue to grow, pushing stock valuations down. This momentum played out around this point in the previous economic rebounds of 1983-84, 1993-94, 2004-05 and 2009-10. In short, we will witness a strong surge in profits as the stock market stalls, or even corrects itself.
This will reset equity valuations lower, eliminating one of the main concerns for investors – high valuations. If S&P 500 earnings reach $ 220 by the end of the year and the index is between 4,000 and 4,100 points due to a correction, stocks will have a price-earnings ratio of 18 to 19, below the average since 1990.
True to form, the Dow Jones Industrial Average DJIA,
and the Russell 2000 RUT,
the small cap index moved sideways for two to four months. The S&P 500 and the Nasdaq COMP,
recently moved out of the trading ranges, but a larger pullback would send them back into lateral action mode.
6. The feeling is not extreme
Against the grain, I look for over-feeling as a sign that it’s time to raise funds. We don’t see it yet. A simple gauge to follow is the Investors Intelligence bullish / bearish ratio. It recently entered at 3.92. It’s close to the warning path, which for me starts at 4. On the other hand, mutual fund cash was recently at $ 4.6 trillion, near all-time highs. This represents the caution of investors.
Three themes to follow
If we expect a sustained economic recovery and a multi-year equity bull market, it will pay off to follow these three themes.
Favor cyclicals. Stick with economically sensitive companies and increase your participation in the event of a withdrawal. This means cyclical companies in areas such as finance, materials, industrials and consumer discretionary.
Avoid defenses. If you want yield, go for stocks that pay a dividend but also have the potential for capital appreciation – not steadily growing companies selling commodities like consumer staples. On this topic, in my stock letter Brush Up on Stocks (link is in bio, below), I recently suggested or reiterated Home Depot HD,
in retail, B. Riley Financial RILY,
a market and investment banking brand, and Regional RM Department,
in consumer credit.
Focus on emerging markets. Their growth tends to be higher during expansions. Just be careful with China. It has an aging population. Limited labor force growth can hold back economic growth. Another challenge is that continuing tensions between the United States and China and the associated threat of lingering tariffs and trade barriers are pushing global companies to relocate their supply chains elsewhere.
Michael Brush is a columnist for MarketWatch. At the time of publication, he owned RILY and RM. Brush suggested HD, RILY, and RM in their stocks newsletter, Brush Up on Stocks. Follow him on Twitter @mbrushstocks.