Posted by Shyam Moondra
The economy has been steadily picking up with industrial production, retail sales, consumer confidence, productivity, and GDP, all gradually increasing. Even unemployment has begun to decline, albeit slowly. The housing market continues to be a laggard, however. The corporate profit margin is at 18-year high and the corporate balance sheets show a record cash hoard of close to $2 trillion.
The revolution sweeping the North African region has reduced the oil output, especially in Libya, pushing the oil prices to $105 per barrel. However, the oil-rich countries need the oil revenues to keep the services in high gear to appease the raged population. Regardless of who is in control in many of these countries, oil will continue to flow and oil prices will eventually come down. In Japan, earthquake and tsunami devastated the eastern part of the country, but the disaster spared the major industrial cities and thus any harm to Japan's overall economy will be short-lived.
Much has been made of the record appreciation in the stock prices over a short period since it hit the bottom in March of 2009. However, what is not receiving much attention is the fact that in 2009 with the demise of Lehman Brothers, takeover of Bear Stearns and Merrill Lynch, and rumored bankruptcies of major banks, the market went down precipitously more than it should have. When it became clear that the major banks wouldn't go bankrupt after all (thanks to TARP), the market bounced back. The market would not have gone down as much as it did, had the investors not panicked. Therefore, the 30-40% appreciation from the bottom should not even be counted as appreciation; it was simply backtracking of an overreaction.
Today, the market is hardly overvalued, as some analysts suggest. The trailing PE of S&P 500 is only 17 and forward PE is under 15. There is no euphoria in the market as we usually see when the market is overvalued. The trading volume continues to be sluggish. During the financial crisis, corporations did an outstanding job in improving their cost-structures that made it possible for them to reap record profit margins and accumulate cash of the order of $2 trillion. The corporate world has never been more financially stronger. The companies are very well positioned to increase dividends and undertake major share buy-back programs that will be a big boon to the current investors. Also, relatively low PE levels will fire-up the mergers and acquisitions market, further boosting the stock prices.
What will help the economy is a bi-partisan effort to reduce federal budget deficit and national debt. President Obama's proposed budget is utterly inadequate. We need a 3-4 year plan to balance the budget and not a 10-year plan. A serious effort by the Congress and the Obama administration to reduce the budget deficit is a pre-requisite for sustained recovery and long-term prosperity.
Any talk of big market correction is pre-matured. The market has a long way to go before we see irrational exuberance. If the housing market turns around and a plan is adopted to reduce the budget deficit in a meaningful way, the DJIA could top the old high of 14,198 by next year. We might see intermittent small corrections caused by profit taking, but we are in a secular bull market, which may last for several years until S&P 500 PE reaches to high-20's and DJIA hits 18,000. Warren Buffet recently said that he is itching to buy; his purchase of Lubrizol for $9 billion is just the beginning. When Buffet is bullish on America, any talk of a major market meltdown is pure nonsense.
