Posted by Shyam Moondra
The U.S. economy has been steadily gaining momentum with industrial production, retail sales, consumer confidence, productivity, and GDP, all gradually increasing. The corporate profit margin is at 18-year high and the corporate balance sheets show a record cash hoard of close to $3 trillion. The auto industry is selling vehicles near record levels with GM reporting the highest profits ever in the latest quarter. Even unemployment rate, currently at 8.3%, has begun to decline, albeit slowly.
The recovery from the 2007 recession has been slower than usual and economy is taking longer than usual to get back to the pre-recession level. There are many reasons for this sluggish recovery: first, the 2008 financial crisis led to credit freeze that caused the recession to be more severe than other recessions of recent decades; second, extraneous factors such as Japan’s tsunami devastation, Europe’s debt crisis, and political gridlock in Washington, DC on the question of extending the debt ceiling made it impossible for the U.S. economy to recover in a timely manner. Every time economy seemed to show signs of recovery, it would be knocked down again and again by extraneous factors.
The following trends suggest that all the pieces are now coming together and the pace of the U.S. economic recovery will become more intense and the financial markets will show sustained significant appreciation over the next 2-3 years, with the Dow Jones Industrial Average (DJIA) hitting an all-time record of 18,000:
• The political gridlock in Washington, DC is becoming less intense, as is evident from the recent rather quick agreement between the Democrats and Republicans on extending the payroll tax cut until the end of this year. Republicans learned from their contentious way of handling the debt ceiling debate, which led to the downgrade of the rating of the U.S. government securities from AAA to AA+, that they were losing public support in a big way with a disapproval rating of Congress hovering around 90%. This doesn’t mean that political gridlock is gone for good, but it does mean that Republicans would have no choice but to behave or else they will end up losing the general election in November. The tranquility on Capitol Hill is having a positive effect on the corporate confidence that has in recent weeks led to increased capital spending, brightening the job prospects.
• The on-again and off-again EU debt crisis has caused up-and-down movements in the U.S. financial markets. However, yesterday’s agreement on a second bailout for Greece is finally bringing some closure to this issue. The EU debt problem is by no means completely resolved, but the recent developments have brought more clarity and given some breathing space to deal with the problem in an incremental way over the next 2-3 years. The EU debt situation was a big impediment for the U.S. stock markets; so with the latest Greece bailout agreement, we can now expect the stock markets to move up.
• The Federal Reserve Board recently announced that they will maintain their low-interest rate policy through 2014. They also said that the Quantitative Easing 3 (QE3) remains on the table (although as the economy gains momentum, the chances of QE3 are eroding by day). Low interest rates combined with relatively low inflation are creating an ideal environment for stock markets to appreciate considerably. The up-tick in stock prices will lead to increased consumer spending, giving a big boost to the economic recovery.
• The signs are beginning to emerge about the bottoming out of the housing market. The recent $25 billion settlement between the major banks and the federal and state governments bode well to bring down foreclosures in the coming months. The home builders are expressing increased confidence and are now increasing the pace of new construction. Increased housing prices in the coming months will act like a stimulus to economy, thereby aiding the overall economic recovery.
• The present market valuations are too low and stocks look very attractive. The current S&P 500 has a PE of around 14 (recent peak in 2000 was 35). The forward PE is currently at 13, making the stocks very cheap at a time when corporate earnings are at an 18-year high. It’s remarkable that companies like Apple have continued to produce record profits during the current recession and yet the PE ratios remain at levels of 10 years ago. This shows that at current prices there is tremendous potential for stock price appreciation.
In spite of the above favorable trends, there are worrisome issues on the horizon that the government agencies such as SEC and CFTC need to address. The SEC needs to be more aggressive in dealing with the problems of market manipulation and insider trading. With the advent of high-speed computers, the big players have found ways to manipulate the markets via high-frequency trading and quote-stuffing that are turning off small investors, who question the integrity of the markets. The recent speculative oil price increases, at a time when seasonally we expect lower prices, point to the need of stronger measures by CFTC in making sure that commodity markets are not manipulated by speculators.
