Long-term positive effects of fair and equal trade policies will push financial markets to new highs

 
Posted by Shyam Moondra

During the 2016 presidential campaign, President Donald J. Trump emphasized tax cuts and deregulation as a means to spur economic growth and he successfully achieved that. Since those policies were enacted, the GDP growth has gone up to as high as 4%, unemployment has gone down to the lowest levels in the last 50 years, and manufacturing base is growing again. These positive economic results also led the financial markets to set all-time records. 

During the 2016 campaign Trump also talked about doing something about the U.S. trade deficit with our international trading partners that has been steadily growing since the 1990s and currently stands at around $800 billion. China, Mexico, Japan, Germany, and Canada are the largest beneficiaries of trade deficit with the U.S. This enormous wealth transfer has decimated the U.S. manufacturing base with neighborhoods in many of our industrial hubs becoming no-man’s land, especially in Michigan, Ohio, Pennsylvania, New York, and Illinois. Trump aggressively used tariffs as a tool, based on national security concerns, to renegotiate trade deals with many countries. He successfully concluded revisions to NAFTA and struck a new trade agreement with Canada and Mexico (USMCA) which will stop the hemorrhage of manufacturing jobs to Mexico and Canada and also open up those markets for the American agricultural products and poultry. Trump also successfully renegotiated a new trade deal with South Korea. New trade deals with Japan and the U.K (in post-Brexit era) are almost done. 

Negotiating new trade deals with China and EU have proven to be more difficult than expected. These negotiations were also exasperated by the Federal Reserve Board that increased interest rates in rapid successions last year even though inflation was within their target range (FED kept rates near zero percent during the Obama presidency but they increased the rates to 2.5% during the Trump presidency); higher interest rates strengthened the USD which made U.S. trade negotiations even more difficult. In the case of EU, Trump is holding the card because if he imposes tariffs on EU automobiles, it would devastate the EU economy. At some not too distant point, the EU would have to reduce tariffs on American imports and also open up their markets for American agricultural and energy products. China, the biggest beneficiary of trade deficit with the U.S., has proven to be a tough negotiator. We have seen a few rounds of tariffs and retaliatory tariffs that have rattled the financial markets in both countries. In Trump’s calculations, since China is benefiting from the huge trade surplus with the U.S., they have more to lose from a trade war. The trade war with China has forced American companies to explore alternative non-Chinese supply-chain arrangements involving other low-cost countries such as Vietnam, Malaysia, Indonesia, Thailand, and India (some jobs are even returning to the U.S.). However, the trade war has created uncertainty and it has dampened capital investments by multinational companies, especially in China. These trends have slowed down global economic growth and they have rattled the financial markets around the world. Surprisingly, the U.S. economy has proven to be more resilient to the negative forces unleashed by the trade war and it continues to do relatively well albeit at a slower growth rate than before.

The stock market in the U.S. has not yet discounted the long-term implications of a new trade world order which will greatly benefit the U.S. in terms of higher growth rate, continuing decline in unemployment rate, and increasing wages as many high-paying manufacturing jobs return to the U.S. If and when Trump announces new trade deals with China, Japan, the U.K., and EU, we will see increased economic activity in the U.S. with reduced wealth transfer to other countries. Since inflation is muted, the Federal Reserve Board will likely reduce interest rates in the U.S. to complement growth-oriented fiscal policies that might include a new massive infrastructure spending plan. Recently, ECB announced a new QE program which will also give a new impetus to global growth. These positive trends will propel the U.S. stock market to new highs. In the near-term, we will see a much stronger U.S. economy with S&P 500 Index hitting a new record high of 3,400 as early as next year. In the long-term, as the new trade deals set in, S&P 500 Index could even hit 4,000 by 2022. Trump’s fiscal and trade policies are indeed transformative and these policies will produce good results for years to come.

Stock market on track to hit 18,000 by early 2014

Posted by Shyam Moondra

In 2011, I predicted that DJIA was headed to 18,000 (“We are in a secular bull market - DJIA headed to 18,000,” The Moondra Post, March 14, 2011) and it looks like we are on track to achieve that record high by early 2014. Given that the current bull market is now more than five years old, many prominent analysts are predicting that a market crash of 10-20% is imminent. However, I believe that the bull run is not yet over.

The following trends favor a continuing up move in the stock market at least through March, 2014:

• The stock valuation is high but the market is definitely not overpriced. The forward PE of 15 for the DJIA, as currently estimated by WSJ, is by no means excessive compared to the high 20’s at the recent market peaks of 2000 and 2007. The market would look pricey if PE were to get close to high-teens, given that we are currently in a low-growth environment compared to the go-go years of the early 2000’s.

• Corporate profits continue to be at record levels, thanks to a superb job done by the corporate world in managing their cost-structure through the great recession in the aftermath of the financial crisis of 2008. Given that economy is currently strengthening (3Q13 GDP growth rate revised upward to 3.6%), further gains in corporate profits are predicted for 2014. Accordingly, there is room for continuing expansion of the PE multiples of the stocks.

• The unemployment rate has steadily come down to 7% from double-digit numbers at the height of recession, which means consumer spending would continue to increase in the foreseeable future. Also, increases in the stock prices and recovery in real estate prices have pushed the household wealth to record levels which would also guarantee increased consumer spending. Since consumer spending accounts for 70% of the economy, the economic activity would continue to be in high gear which would lead to further reduction in the unemployment rate, creating a sustainable upward spiral in GDP.

• Interest rates and inflation continue to be at low levels that always favor the stock market. In the near- to mid-term, we might see a spike in interest rates from the current 2.8% to 3.5% (on 10-year treasuries), but historically we would still be at relatively low levels. Since the corporations have a record cash hoard of the tune of $4 trillion, they may not have a huge need to borrow to support their capital expansion plans and thus the impact of higher interest rates on the economy could be somewhat muted.

• Currently, there is too much cash lying around in money market accounts and the stock market lacks euphoria which is typically seen at the market peaks (that's when stock prices go up sharply with heavy volume). That means the stocks have not yet peaked and that we would see a continued upward move in the stock prices.

• Europe and emerging markets are showing early signs of recovery after unprecedented austerity measures (taken to reduce budget deficits) devastated their economies. The U.S. recovery combined with recovery in Europe and emerging markets would give a further boost to global trade which would increase the U.S. exports and corporate profits.

• Finally, much has been made of the impending Fed tapering of their monetary stimulus program, QE3, in which the Fed buys government securities at a rate of $85 billion a month. The Fed has said that when economy improves and unemployment rate falls to 6.5%, they will phaseout monetary stimulus. The recent GDP growth rate of 3.6% makes it likely that the Fed would start tapering QE3 in 1Q14. Theoretically, QE3 tapering would have some negative impact on the stock market, but there would be some offsetting factors as well. As the interest rates increase in the face of tapering, the bond bubble would finally burst and some of the bond money would end up in stocks. Also, the underlying economy would be stronger and that means corporate profits would remain healthy. Therefore, tapering may not necessarily be a bad news and the fears of market crash are overblown.

Given the above global economic trends, there is a possibility that the DJIA might even surpass the 19,000 mark some time in 2014.

Bull market is alive and well – it has a long way to go

Posted by Shyam Moondra

The DJIA is ready to crack the 15,000 mark this week or next for the first time in history and short sellers are scratching their heads. Since the market hit a low of 6,443 in March of 2009 at the height of the financial crisis, it is now up by 130%, making it one of the strongest comebacks ever. The bears, who thought an impending crash was a sure bet, are totally confounded at the resilience of the market.

I have written about the unfolding market story and predicting a long-term bull market that will take us to the 18,000 mark on DJIA by the end of 2015 (“We are in a secular bull market – DJIA headed to 18,000,” March 4, 2011; “Market impediments dissolving – DJIA headed to 18,000,” February 21, 2012; “Analysts behind the curve – market entering a major bull phase,” March 16, 2012; and “Bull market continues – DJIA headed to record high,” January 1, 2013). The current market conditions only reinforce my prediction.

It’s worth noting the following trends:

• When market goes up big (100+ points) with heavy volume several days in a row, exhibiting "irrational exuberance" (a term coined by former FED Chairman Alan Greenspan), it is usually a sign that the market has peaked. However, this is not what is currently happening; the market has been going up sluggishly with light volume, which means that it has a long way to go before we see a major correction.

• The current market rally is unusual in the sense that “not-so-sexy” stocks (such as Pfizer, Merck, Microsoft, IBM, Verizon, Coca-Cola, etc.) are going up but many industrial and financial companies (e.g., Alcoa, Bank of America, Citigroup, Caterpillar, Exxon Mobil, Apple, Dow Chemical, etc.) have not yet participated in the rally. This unevenness actually sets the stage for rotation and a continued bull run in the near-term.

• The corporate earnings are at record levels, thanks to their masterful management of their cost-structures and cautious capital expansion, which, of course, explains a slow pace of improvement in the job market. The corporations have one of the strongest balance-sheets ever, with $4 trillion of cash pile that will fuel further capital expansion and job creation in the coming months and years.

• The housing comeback, healthy auto demand, and surprisingly strong energy sector are contributing to economic recovery.

• We continue to enjoy an environment of low interest rates and low inflation that is usually ideal for market rallies.

• Increasing housing prices and higher stock prices are creating the wealth effect which would encourage consumers to spend more and thus continue to fuel the economic recovery.

• Many analysts view impending winding down of FED’s QE 3 as a catalyst for the market crash. If the FED does this gradually, all in all, we will actually see a stronger market for two reasons: first, the stimulative effect of QE 3 is unleashing economic expansion which would easily absorb the gradual unwinding of QE 3 and, second, as the interest rates go higher, the bond bubble will finally burst and some of that money will move to equities and thus keep the stock market rally going.

• Finally, based on historical standards, the current stock valuation is very attractive. WSJ reports that the trailing PE ratios based on operating earnings (i.e., excluding one-time extraordinary items) are as follows: DJIA 13.05, S&P-500 14.10, and NASDAQ-100 15.00. These ratios are, by no means, excessive (at the last market peak, these ratios were in high-20’s to low 30’s). Given that the economic growth is slower now than in the past, we may not see that high PE ratios any time soon, but from current levels the market could easily go up by 20-30% before beginning to look pricey.

Yes, as the market goes up, there will be intermittent profit-taking which will cause small corrections along the way, but a major bear trend is not in the cards, as yet. In fact, in the current bull run, we could witness one of the strongest short squeezes we have ever seen.

The stock market decline is driven by fear and misconceptions

Posted by Shyam Moondra

The stock market is in a downward spiral. Since April 26, 2010, when the market set the 52-week high, DJIA has declined over 12%. After having risen 74% from the crash bottom set on March 6, 2009, it was expected that the market would have a correction. However, the intensity of decline (as much as 25-30%) in the prices of shares of some of the companies in the financial and technology sectors is baffling. The market decline lacks conviction given the relatively light trading volume. The market sentiment has become overly negative, which may be a sign of the market bottom. Every little bad news gets overblown and good news gets discounted. In the last couple of quarters, the economy has been recovering steadily as is evident by the statistics on corporate profits, industrial production, leading indicators, consumer confidence, retail sales, and housing. The numbers on inflation have been very positive. When did stock market decline in an environment characterized by increasing corporate profits, low interest rates, and low inflation?

At the present time, the investors have lost confidence in the strength of the economic recovery, largely based on fear and misconceptions. Here are some observations:

· When an economy comes out of recession, it does not recover in a straight line. Initially, it's always a slow process consisting of two steps forward followed by one step backward. That's quite normal as the economy goes through the phases of structural adjustments during the post recovery period.
· The Europe debt problem is being blown out of proportion. The U.S. banks have no more than $60 billions worth of exposure to Europe, which is like a drop in a bucket, considering the size of the total assets of these banks. It's doubtful that there will be any defaults on sovereign debt, so long as the countries are prepared to tighten their belts and IMF is ready to help them out. Yes, in the near-term, reduced government expenditures would slow down the European economy a little, but the budget cutbacks will have very healthy long-term impact in terms of keeping the interest rates low and in keeping the economic recovery going on a sustained basis. So what is going on in Europe is not as bad as some fear-mongers would like us to believe. In fact, today, Germany announced that manufacturing orders in the month of April unexpectedly rose 2.8% compared to the previous month; this was a good news but it apparently got lost amidst the panic driven market decline.
· In the last two months, the economy has actually created new jobs. The unemployment rate is a lagging economic indicator, so obviously this is the last category of improvement we would see as the economy recovers. The data for the current year has nothing in it that would suggest that the economic recovery is getting off track. The employment numbers reported in the coming months would prove that. While it is true that it may take a few years before we again see the unemployment rate closer to 4.5%, let us not forget that 90% of the workers are currently employed and they have done an extraordinary job in controlling their spending and saving more during this recession than any other prior recessions.
· The corporations have $1.5 trillions cash on their balance sheets, which is a record. Some of this cash will end up in capital investments that will create new jobs. The corporations did a very good job in controlling their costs throughout this recession (via low inventories and painful work force reductions); as a result, the productivity gains would contribute to their higher profit margins as the economic recovery gains momentum.
· The pace of innovation picked up even during the recession, as is evident from the new products being offered by technology and other companies. There were hundreds of people waiting in lines for hours in London and Paris to get their hands on Apple's iPad. Doesn't that say loudly that one should never underestimate America? The U.S. has always been on the forefront of innovation and we will continue to dominate the world and create high-paying jobs. One has to have faith in what we can do.

Given the American entrepreneurial spirit and genius, one can never doubt where we are headed. The current pessimism and fear are misplaced. The beaten down stock prices are in fact an excellent opportunity to invest for the long-term. The market correction has run its course and it seems ready for a big up move.

Stock market is ready to explode - DJIA headed to 12,000

Posted by Shyam Moondra

Yesterday, the Federal Reserve Board announced that they expect to hold interest rates low for an extended period of time to let the economic recovery take firm hold. Today, the Labor Department announced that Producer Price Index declined by 0.6% in February. Low interest rates and low inflation are like music to the ears of the stock market and yet the market has moved up only slightly with a very low volume. It's possible that investors are holding back because of the recent mixed consumer confidence and housing data that prompted some to entertain the thought of second dip in the economy. However, those unfavorable economic indicators may have been distorted because of one of the most severe snowstorms in the North East region in the last fifty years.

It's hard to ignore the following encouraging signs that suggest that economic recovery would accelerate in the coming weeks and months:

· The corporations with low inventories are lean and mean; any up-tick in the demand for goods and services would significantly increase their profits and employment levels.
. Manufacturing has a lot of unused capacity which means that economy can recover without rekindling inflation.
· The corporate world has very strong balance sheets, hoarding over $1.4 trillion cash that could fuel the capital investments over the next couple of years.
· Consumers are being cautious because of lingering high unemployment level; however, they have also shown their willingness to make big purchases as is evident by a strong pick-up in the automobile sales. They will start spending more freely, once they are convinced that economic recovery is taking hold.

The present cautious stock market is in fact a prelude to a stronger and sustained up move with heavy volume in the coming days and weeks. Based on the forecasted 50% increase in corporate profits this year, the Dow Jones Industrial Average could head to 12,000 by the end of third quarter and even hit 13,000 by early next year.

As the paper profits pile up, investors would be tempted to take profits and thus DJIA's move to 13,000 would not be without wild swings. At any sign that the market has temporarily peaked, there will be a floodgate of profit taking which will push the market down but then bargain hunters will move in and the market will move up again on a short order. The key to maximizing the returns would then be to have a good sense of timing in terms when to take profits and when to move back in.

This year and the next are the golden opportunities for investors to make good money, but only if they could master the art of market timing.

Today's stock market decline may be an overreaction - it's time to buy

Posted by Shyam Moondra

Today's stock market decline may be an overreaction to the disappointing report on new jobless claims. However, the broader indicators continue to be positive, and, therefore, today's market sell-off may turn out to be a buying opportunity.

Recent market reports have generally been good:
· The corporate earnings in the fourth quarter of 2009 exceeded consensus estimates of the analysts. The average PE ratio for S&P 500 stocks now stands at 19, with the projection for 2010 at around 15. This, by no means, makes the stocks as too expensive.
· Sharp productivity gain of 6.2% in the fourth quarter of 2009, the largest gain since 2003, means the corporations have brought down their cost-structure considerably by staying lean-and-mean through the 2008-9 recession. That means, even a slight pick up in demand could significantly boost the corporate profit margins.
· In recent months, industrial production, orders for durable goods, and service industry index have all increased.
· The housing market has stabilized, with increasing home sales and a slight up-tick in the home prices.
· The consumer sentiment and personal savings continue to be positive.
· The market decline may bring an unintended benefit of taming the inflationary expectations that will make it easier for the Federal Reserve Board to phase-in higher interest rates in the second-half of this year.
· The technology sector took a hit in recent weeks, which is actually good for the market. This sector was running ahead of the overall market, making it difficult to sustain the market's upward momentum. However, with the healthy correction in the technology sector, the market is now poised for a sharp up move, led by these same stocks that caused the recent decline in the market.

While the job market has proven to be stubbornly sluggish, as is evident from today's report on new jobless claims, this is nevertheless a lagging indicator. The Senate is considering the new job creation bill that will give a boost to the job market soon. The consumers are not necessarily going to wait for actual job growth before they start aggressively spending again; all they are looking for is an indication that the job market has stabilized and it may soon start growing again.

In this environment, consumer-oriented stocks (such as banks, casinos, hotels, airlines and consumer staples) and technology stocks look attractive.
(Disclosure: The blogger owns stocks in most of these sectors)

Economic recovery may be erratic but it's on right track

Posted by Shyam Moondra

President Barack Obama has been in the oval office for only a few weeks but he has moved at a lightning speed on several fronts simultaneously. While his actions may not be perfect, he seems to have a good intellectual grasp of how the various pieces of the puzzle fit together. Undoubtedly, some critics on the other side of the political divide would say that he is on a wrong track. However, given the awful results of the George Bush presidency, it's hard to support the Republican ideological viewpoint that doing anything differently from what President George Bush did automatically puts you on a wrong track.

Never before, economic fortunes crumbled worldwide in such a short period. Low interest rates of the 1990s fueled the housing market prompted by innovative products such as sub-prime mortgages, mortgage-based securities, and credit default-swaps. The business was so lucrative that financial institutions around the world jumped on the bandwagon without ever bothering to fully assess the enormous risks involved and made a fortune. But when the FED started increasing interest rates to tame the fears of inflation, the house of cards began to crumble. Reduced demand for housing led to rapid decline in home prices that, in turn, led to the floodgate of defaults and foreclosures. The financial institutions that grabbed the mortgage-securities began to see the values of those securities evaporate and they were forced to report huge losses bringing them closure to bankruptcy.

The Obama administration moved swiftly to address the issues in a top-down as well as bottom-up fashion (as I suggested in "Combine top-down and bottom-up approaches to deal with the credit crunch," The Moondra Post, September 30, 2008) by offering assistance to the financial institutions through TARP and FED credit facilities as well as providing help to the homeowners to stay in their homes. The stimulus package, recently passed by Congress, includes tax credits for home buyers that should help reinvigorate the housing market. The Obama's proposed budget includes income-tax reductions for 95% of the taxpayers that will induce them to spend more, thereby boosting the economy. The budget also includes massive spending for infrastructure projects that would instantly create new construction jobs. In addition, the proposed budget includes long-term investments in alternative energy technologies (that will create new high-paying jobs and reduce our dependence on imported oil), health care (that will reduce health care costs), and education (that will increase our competitiveness in the world), The Obama administration's multi-pronged approach to the economic collapse is well thought out and it will yield positive results over time. While it's true that the budget proposal has many pork-barrel wasteful spending appropriations, overall, it has many more positive elements that are necessary under the present dire circumstances.

Not to forget the last piece of the puzzle, the regulatory reforms. Lack of regulations and oversight led to the collapse of the financial system. So it's not surprising that the Obama administration is aggressively moving to bring the regulatory regime to the twenty-first century. We need to regulate investment banks and hedge funds, monitor and regulate computerized trading to eliminate market manipulation (ban naked short selling, limit short selling to 1% of outstanding shares, require institutions to hold stocks they buy for a certain minimum period before they can sell those stocks, and limit trading in derivatives such as options), and impose strict capital requirements on all financial institutions (no more 40:1 leverage used by many investment banks and hedge funds).

The increased spending to jump-start the economy will certainly add to our budget deficit and national debt in the near-term. That's why President Obama is already looking beyond the near-term and he has proposed to reduce government expenditures (e.g., changes in defense contract procedures and health care reforms will save billions of dollars) and increase taxes on the richest (who prospered handsomely during the Bush years and now must give up some of those gains). It took President Bush eight years to turn a budget surplus into a huge deficit, so it's reasonable to expect that it will take a concerted effort by the Obama administration over the next several years before we see a budget surplus again.

In spite of the above dramatic initiatives, we are continuing to see unemployment on the rise and corporate profits on the decline, but the actions taken by the governments around the world create just the right conditions for an economic recovery. Lower interest rates, increased government expenditures, lower taxes for the middle-class, and regulatory reforms will boost the global economy soon. These conditions are ideal for the financial markets, so President Obama was right in his recent observation that long-term investors should start buying dirt-cheap stocks. The current average PE ratio of S&P 500 index of 12, while not as low as 6 of July 1932 and 7 of July 1982, is much lower than the latest 25-year average of 21 and 50-year average of 18. The decline in the average PE ratio from the recent peak of 44 set in 2002 is the worst since the depression of the 1930's. The conditions today are, however, very different than those in the 1980's when we had double-digit inflation and double-digit interest rates. Today, we have annual inflation rate of about 2% and fed funds rate of 0.5%. Therefore, the stocks are indeed very cheap with a huge upside potential.

Aside from the differences in policy directions, there is a stark difference in mostly reactive mode of operation of the Bush Administration and a pro-active comprehensive approach of the Obama administration. President Bush had no long-term vision and he never believed in a deep governmental involvement in free-market economy. President Obama works off a well-thought out strategic vision bringing in the full weight of the government to make his initiatives yield the results quickly. If President Obama continues to show vigor and remains a hands-on chief executive as he has been so far, chances are we will begin to see the results of his stimulus package and the proposed budget plan as early as in the second-half of 2009 and by 2010 we should be well on our way to recovery and renewed prosperity.