Last week saw stock market indices achieve new highs. Moreover, we believe that forces are conspiring to bring you a year-end Santa Claus Rally.
Why?
To begin with, last week brought a palace coup that saw Democrats lose the Senate, as well as additional seats in the House. Should be positive for defense and domestic discretionary spending. Not to mention the financial sector. Moreover, the promise of a split, do-nothing government may drive voters crazy but provides manna from heaven as the market Gods love nothing more than some rigid Washingtononian gridlock.
Also, the Bank of Japan significantly increased its quantitative easing. This puts further expectations on the European central bank to do the same. In addition to the easing, Japan's largest government pension fund announced its decision to put a massive cash allocation to work in U.S. stock and bond markets. At the very least, the additional easing and Japanese capital inflows will serve as a tide that lifts all ships. If tides were made of money. And boats were stocks.
U.S. economic growth will hit 3 percent or better in the second half of 2014. The dollar continues to strengthen, helping to keep inflation in check. And Q3 earnings continue to surprise to the upside. While falling oil prices will feel like a tax cut for Christmas shoppers.
Last Wednesday, the Fed completed its $3 trillion asset purchase program, AKA QE3. That morning, former Fed chair Alan Greenspan warned that he "does not think it's possible" that the Fed can unwind years of extraordinary stimulus without causing turmoil in financial markets. But the Fed will keep -- not sell -- what it has bought, reinvesting interest and rolling over maturing securities. With such sizable cash flow, the Fed will continue to be a large bidder in markets.
Accordingly, we expect volatility to rear its head mightily when the Fed begins to hike interest rates in 2015 or 2016. Till then? Game on. Further, we have history on our side.
Nancy Lazar, head economist and founder of Cornerstone Macro Advisors has noted that "prior to every major upturn in U.S. and global economic activity, commodity prices and global short rates declined. So, these recent moves are very supportive of growth in 2015."
Recently, Commodity costs have plummeted. Brent oil has fallen 27.5% from its 2014 peak. Gas futures plunged 31.7% from their June peak. Ag and livestock prices have fallen 18% since April.
Nancy contends that these tailwinds will be supportive of U.S. growth for four reasons:
1) U.S. households and small businesses have significantly deleveraged, with private debt as a percentage of GDP down to 144% from a 2009 peak of 169%.
2) The U.S. banking system has recovered, and appears to be working effectively.
3) The U.S. has long-term growth drivers, like housing, capital spending, oil exploration and production.
4) Finally, the U.S. consumer outlook is improving, with household incomes up and solid employment gains.
Per the evidence, the game should soon be joined by mutual fund and hedge fund managers, both of whom have woefully under performed their benchmarks. The recent market pullback also sent many of them to cash. Then rebounded too quickly for them to redeploy capital. So, you now have a bunch of guys whose livelihoods and bonuses depend upon their performance having underperformed year to date. In the midst of a TINA market (There Is No Alternative). Which means they will shovel cash into stocks. Chasing performance likes weasels in a hen house. Which, for you non-farmers, means its bullish
Bottom line? Fundamental developments support continuing stock market appreciation. While we should expect the occasional two to five percent pullback, institutional managers will use these dips to buy more, rather than using advances to sell. Because, in a TINA market, what else are they going to do?
The Good
The Midterms? Over. Which means we might briefly put politics behind us... Senator McConnell, the incoming Majority Leader, stated that the GOP will neither shut down the government nor obstruct increases in the debt ceiling... The Keystone Pipeline will likely get approved... The October jobs report? Stellar. Bringing the unemployment rate to 5.8%... Q3 earnings continued to outperform... ISM manufacturing beat expectations...
The Bad
The Russian ruble and economy continue to get crushed... ISM Services was weaker than expected... Investor sentiments, as reported by the AAII, reached another high. Which is a negative contrarian indicator... Eurozone growth estimates were lowered... Q3 revenues have disappointed... The trade deficit widened...
The Ugly
Student debt. With nearly $100 billion of federal student loans in default, it has gotten out of control.
The Bottom Line
Interest rates remain low. Inflation is in check. Global banks are working in concert to pump up economies. And seasonality is on our side. This market wants to rise. That said, everyone -- including much of the institutional investment community -- expects the next shoe to drop at any time. As Humphrey Neil concluded in his 1954 treatise on investing, two of the top ten means to guarantee failure are:
1) Following the Public
2) Becoming Impatient
So don't. Stick to a plan. Keep your stops tight. Learn from history. And take what you can get while you can.
Weekly Results
Major markets finished higher last week. The DJIA rose 1.05%, the S&P 500 gained 0.68%, and the Nasdaq advanced 0.04%. Small cap stocks fell 0.02%. And the 10-year Treasury bond yield fell thirty-six basis points to 2.30%. Gold rose $4.50 per ounce, or 0.38%.
