Posted by Shyam Moondra
The stock market continued to go up while negotiations between the Republicans and Democrats on “fiscal cliff” were still in flux, which suggests that the investors correctly anticipated that a deal would eventually be struck to avert falling off the cliff. In 2011, Republicans led the ugly debate on increasing the debt ceiling, which resulted in the downgrade of U.S. securities from AAA to AA+, and for that they got punished by the voters in the 2012 presidential and congressional elections. Apparently, Republicans realized that their continued intransigence was a sure prescription for self-destruction and, therefore, they went for the best “fiscal cliff” deal they could get from the Democrats. A wise political recalculation would again pave the way for successful negotiations on extending the debt ceiling before the end of March, when the U.S. Treasury will run out of options for avoiding a historic default by the U.S. government on its debt, and enacting tax reforms as well as spending cuts to reduce budget deficit. Investors seem to believe that Republicans are highly unlikely to cause a default or use government shutdown as a political ploy to achieve leverage in negotiations with the Democrats on fiscal matters.In addition to the marginally improved political climate in Washington, D.C., the following economic trends suggest that the stock market may be ready to go up to record levels this year and DJIA may even hit 18,000 by the end of 2015.
• The EU situation has stabilized and the recent painful austerity programs would yield positive results in the future. The weak Euro would also help the Euro Zone countries with their export business, which would be positive for the global economic recovery. In 2012, real GDP contracted by 0.3% in the EU and by 0.4% in the Euro Zone. In 2013, GDP is projected to increase by 0.4% in the EU and by 0.1% in the Euro Zone.
• After a slowdown in 2012, the recent data on manufacturing and real estate prices suggest that the Chinese economy may be poised to rebound this year. A higher rate of economic growth in China would be a big plus for the global economy.
• In the U.S., economy continues to grow, albeit at a tepid pace, and it continues to create new jobs. In the past month, economy added 155,000 new jobs (over 4 million new jobs created in the last 27 months). The automobile demand continues to be near record levels and the housing data for recent months suggest that a gradual recovery in the housing industry is afoot. The housing rebound could prove to be a strong catalyst for a rapid growth in the GDP. Higher housing prices would also create a wealth effect, boosting consumer confidence and spending. The stock market has also recovered from the crash of 2008. Higher stock prices have increased the wealth of individuals, which would further increase consumer spending. One other sector which is unexpectedly doing well is energy; this industry is not only creating new jobs, but it also has the promise of our achieving energy independence within the next decade. Such a milestone would be a big plus for domestic economic growth and for our enhanced competitiveness in global trade.
• Slow but sustained economic growth combined with superb management of costs by corporations would produce handsome profits going forward, thereby boosting the stock prices. The corporations are enjoying record profit-margins and they have accumulated over $4 trillion of cash on their balance sheets that would guarantee further capital expansion and more hiring in the coming months and years.
• As the economy recovers, FED will probably start raising interest rates as early as next year, at which time the bond bubble will burst and part of that money will end up in equities, giving the stock market a further boost. Also, the fear of rising interest rates will induce the potential home buyers to start buying homes, which will be good for the economy and corporate profits. Higher interest rates will increase the interest rate margins for the banks, thereby increasing their profits. In 2008, weak financial sector brought down the economy and the stock market; in 2013-2014, we would probably see a strong financial sector leading the stock prices higher.
• In the near-term, the devastation caused by Hurricane Sandy and Nor'easter storm in the North-East will lead to extensive rebuilding efforts that will add to the GDP growth and corporate profits.
• Finally, the current stock valuation looks very attractive relative to future growth potential, given the present low interest rate/low inflation environment. The WSJ reports the current price-earning ratios for the trailing twelve months as: DJIA 14.92, S&P 500 17.28, and NASDAQ 16.45. Based on the historical trends, these ratios could rise to low-20’s before the stocks begin to look pricey. Therefore, by the end of 2014, we could very well see DJIA hitting the 18,000 mark.
