Bull market prolonged by sluggish economic recovery – it has more upside potential

Posted by Shyam Moondra

In recent months, the “overheated” bond market has declined with a sharp increase in the yield of the 10-year Treasuries, while the stock market has traded in a narrow range. The bulls are frustrated because the broader stock index DJIA is not moving up faster with heavy volume and the bears are disappointed because the market is not having the expected big correction of 10-20% even after a long bull-run over the last seven years. That leaves the stock market in a limbo and many investors are not sure how to trade, which is apparent from the declining trading volume.

Below is a synopsis of various economic and political factors that suggest that the stocks still have an upside potential and we might see DJIA surpassing the 19,000 mark in the coming months:

·         The economy has been recovering from the financial crisis of 2008 at a tepid annual rate of 1-3% (historically, post-recession recovery rate of 4% is not uncommon), which has prolonged the recovery period beyond the usual four to five years. An over-heated economy coupled with out-of-control commodity markets are a pre-requisite for an impending recession; however, at the present time, we have neither and as such we could see continuing sluggish economic recovery for another couple of years.

·         The jobs numbers have been good but not very strong and, therefore, even after seven years of recovery, we are still not close to the full-employment level (i.e., unemployment rate of 4.5%). As a result, the wage inflation has thus far been negligible, which has allowed the corporations to keep their costs down and allowed FED to defer any increases in the funds rate, thereby continuing with their accommodative monetary policy.

·         The inflation continues to be very low and within the FED’s targeted range, thanks to the decline in oil prices. Given that commodity markets are not over-heated (even after seven years of economic recovery), it’s reasonable to assume that inflation will remain in check for the foreseeable future. Low inflation is always good for the stocks.

·         In recent weeks, the bond market has declined (after an extraordinary bull run that created the bond bubble) with the interest rates spiking up but they still remain below historical levels. Given lower inflationary pressures, the FED is expected to increase the funds rate in small increments starting this year; however, the market has already discounted the first couple of small increases that are likely to take place in September and December of this year. The market will wait and see how these increases continue next year in terms of their magnitude and timing before reacting to interest rate increases. Since next year we have the presidential election, the FED is unlikely to change policies drastically and give the perception of taking sides; therefore, the FED will continue its slow and steady approach at least through 2016. For now, so far as the interest rates are concerned, the stock market has a green light to continue its upward march. As the bond bubble bursts, some of that money could end up in stocks and help with the bull-run.

·         The stock market recovery has also been slow coincident with sluggish economic recovery, which explains why even after seven years of a bull run, the market is not overheated and the stock valuations are quite reasonable. The forward PE of 15.94 for DJIA, 17.81 for S&P 500, and 19.45 for NASDAQ are not excessive and they are much lower than what they were at the market peaks of 2000 and 2007 (when they were in the high-20’s to 90’s range). Also, the current common stock dividend is higher than a year ago and is very attractive compared with the bond yields. Therefore, a case could be made that bonds have room to go down more and stocks have room to go up more.
 

·         The auto and housing sales continue to be very strong, mostly because these markets were hurt really badly by the financial crisis and there was a huge pent up demand built up over the last few years. The current strong demand for auto and houses mean that economy will continue to grow in the foreseeable future and the stock market will keep going up with them.

·         In recent years, European countries have taken unprecedented austerity programs to cut government spending, which, in the near-term, has proven to be painful and it has even slowed down economic growth; however, those sacrifices are beginning to pay off and it is expected that the European economy would start picking up the pace in the coming months. The QE program recently started by the European Central Bank will also help revive the EU economy. Also, strong dollar is increasing the European exports to the U.S., thereby giving a boost to their economy. In the intermediate-to-long term, strong European economy will spur global growth which will also benefit the U.S.
 

·        We have just begun the presidential election season and this time financial markets would be   more sensitive to who is elected as the President than ever before. President Barack Obama is viewed by many, perhaps unfairly, that he is anti-business. Therefore, businesses may favor a business-friendly Republican in the White House, who might reduce taxes, streamline government regulations, and spend more on military.

·         Some of the specific sectors that could be the leaders in the next phase of the bull-run for the stocks could include banks, military system manufacturers, and technology companies.

Given that interest rates are likely to go up this year and next, the banking sector would see their interest spread increase and thus help boost their profitability. The bank stocks, which have gone up in the last couple of weeks, will benefit from interest rate increases and may lead the new bull phase of the stock market. Many banks are currently selling near or below their book values; they could easily move up to at least 1.2 to 1.4 times their book values, assuming we would see more increases in their dividends and buybacks of their own shares in the coming months. If a Republican wins the White House in 2016, it’s safe to assume that bank regulations emanating from Dodd-Frank bill would be scaled back, which will greatly reduce banks’ operating costs and make it possible for them to take greater risks than they are able to do now by lending more to small businesses that could help create more jobs

Recent geopolitical developments such as Russia’s illegal annexation of Crimea, China’s aggressive policies in the South China sea, and the turmoil caused by the Islamic militants in the Middle East and Africa have prompted countries around the world (including the U.S.) to increase the budgets for their defense departments. The U.S. military systems manufacturers are likely to see increased demand for their products and services worldwide over the next several years and thus could become one of the leading sectors to push the stock market up. Given that Republicans favor strong defense, if a Republican is elected as the next President, the stocks of the defense manufacturers would get a big boost.

Although NASDAQ set a new record high last week (beating the last record set back in 2000), the forward PE is only 19.45 compared with 90 in 2000. This suggests that the technology sector could also be one of the leaders that will take the broader stock market to new record high levels in the coming months.

Given that the current stock valuations are not excessive and that we will continue to have low interest rate/low inflation environment for the near-term, the stock market has more room to go up at least for the rest of this year and early next year. At some point in 2016, depending on if a pro-business candidate is elected as the President and depending on inflation situation and how aggressive the Fed is on increasing interest rates, it is possible that we may finally see a correction that many bears have been expecting. But for now, the stock market may continue its slow upward march towards DJIA of 19,000.

DISCLAIMER: The blogger is long in the sectors mentioned in this blog.

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.

To taper, or not to taper – that is the question

Posted by Shyam Moondra

The biggest uncertainty in the financial markets right now surrounds the question of when would Federal Reserve Board (Fed) start winding down (i.e., taper) the Quantitative Easing (QE) program in which the Fed buys treasuries and mortgage-based securities at a rate of $85 billion a month. This unprecedented monetary program was designed to keep the long-term interest rates low, which, in turn, would stimulate economy, especially the housing sector. The Fed was forced to undertake this aggressive approach because the Congress and President Barack Obama were deadlocked on providing stimulus to economy on the fiscal front. The QE has had some success in giving a boost to economy via housing boom and in bringing down the unemployment rate to 7.4% from the peak of 10% at the height of the 2008-2009 financial crisis. The critics of the QE program have argued that easy money would recreate bubbles (e.g., in the housing and bond markets) and also increase inflationary pressures. While low interest rates have created a bubble in the bond market and boosted interest-sensitive stocks such as utilities, inflation continues to be in check (in fact, some fear that we may be in a prolonged deflationary environment similar to the one that Japan had during the 1990's).

Ben Bernanke, the Fed Chairman, has indicated that the goal of the QE program is to bring down the unemployment rate to 6.5% at which time the program could be terminated. The low interest rates and low inflation have boosted the equity prices; DJIA as well as the broader index, S&P 500, have both set all-time records. However, the key question now is when would the Fed start tapering the QE program. The Fed is expected to first reduce their purchases from the current rate of $85 billion a month and then start selling what they already purchased to bring down their balance sheet to more traditional levels. The whole process of tapering and selling their holdings could take years to complete.

It is generally believed that when tapering begins, interest rates would go up and stock prices would go down. The financial markets are beginning to show increased volatility as the possible tapering moment gets closer. The increase in interest yields on bonds and decline in stock prices in the last week reflect the uncertainty as to exactly when the QE tapering would begin. Bernanke is on record saying that the Fed could begin tapering when the unemployment rate goes down to 7% (currently at 7.4%). Many investors believe that tapering decision could be made as early as next month when the Federal Open Market Committee (FOMC) would meet. However, given that unemployment is still not at the level the Fed desires (next unemployment report is due on September 6, 2013) and inflation continues to be within the Fed's target range, the FOMC may decide to defer the decision on tapering to their next meeting in December. If a decision is not announced after their September meeting, the stock markets could soar to new record high and long-term interest rates could get a reprieve from recent run-up.

Given how sensitive financial markers are to the timing of tapering, it may be better if the Fed pulls back from its recent policy of transparency and not be so open on what their plans are. Below are some principles that the Fed could adhere to:

• Tapering and unwinding of their balance sheet should be done in a very gradual fashion, spread over several years. This would minimize severe volatility in the financial markets.

• The Fed should bring their transparency down a notch and not talk about their plans publicly. They should not pre-announce when they would begin tapering and at what rate. If investors don't know, they wouldn't react and that will help minimize volatility and reduce chances of flash crashes in the financial markets. If the Fed tapers gradually without public fanfare, it's possible that it might have very little negative impact on economy, to the point that people might not even notice that taper has already begun.

• The Fed should give out information on tapering and unwinding of their holdings after the fact and only in less dramatic way (e.g., making a vague reference in their meeting notes rather than Bernanke talking about it prominently at a press conference). The less the information given out in a low-key fashion, the better it would be.

Regardless of what the Fed decides on unwinding QE, the long-term prospects for the stock markets continues to be positive. Yes, the interest rates would increase, but given we are so far down from the normal interest rate levels that existed prior to the financial crisis of 2008, one should exercise caution in not overstating the impact of rising interest rates. In any case, given record cash hoards on the corporate balance sheets, their capital expansion plans may not be negatively affected by higher interest rates. Second, the end of QE would also signify significant improvement in the job market, which means increased consumer spending. Since consumer spending accounts for two-thirds of economy, corporate profits would increase even more from their current record levels. Also, higher interest rates would finally burst the bond bubble and some of that money would end up in stocks. Therefore, the recent decline in the stock prices caused by uncertainty surrounding the timing of tapering, could in fact be a good buying opportunity for the long-term investors.

Boehner sure mastered the art of how to lower business confidence and delay robust economic recovery

Posted by Shyam Moondra

Republican Speaker of the House, John Boehner, never misses an opportunity to say something that would demolish business confidence, which, in return, would blunt economic recovery and prolong the misery of unemployed people.

The latest Wall Street Journal/NBC News opinion poll puts Congressional approval rating at record low of 12%. The Congress has been viewed very negatively by the American people for many years but this seems to have almost no effect on Republicans. It’s as if they consider this level of low rating as a badge of honor. In the last year’s election, Republicans lost seats in the Senate and House, and they also failed to win the presidency. One would then think that this might have taught them a lesson and they would behave differently, but no such luck.

Recently, Boehner said that the success of Congressional Republicans should be judged not based on how many bills they pass but based on how many bills they repeal. Next week, Republicans are planning to repeal Affordable Care Act (referred to as Obamacare by Republicans) the 40th time, but it will again be ignored by Democrat-controlled Senate. Some Republicans are even advocating a new tactic to undo the laws passed by the Congress but not favored by a majority of Republicans and that is to unfund those programs. This is a dangerous approach which amounts to making a mockery of the democratic system and is a form of political terrorism. Given the potential huge backlash from the voters just before the next year's elections, many moderate Republicans are not in favor of such an extreme precedent, which could also be exploited by Democrats when they are in control of the House.

House Republicans marvel on their failure to negotiate with the opponents on averting sequestration, which forced across-the-board spending cuts (some of which even Republicans view as harmful to economy). The Congressional Republicans are resolute in putting their rigid political ideology above what’s prudent or in the best interest of the country. Somehow, in their twisted way of thinking, they believe it’s good for their re-election, even in the face of evidence that suggests otherwise. The House Republicans are holding the country as a hostage and they are putting their countrymen through unnecessary pain and suffering by obstructing economic recovery.

Boehner also said that he would not increase the debt limit unless President Barack Obama and Congressional Democrats agreed to cut spending substantially beyond the multi-year cuts that have already been put in place. Last time, Republicans threatened to use the government shutdown as a political tactic on the question of increasing debt ceiling; that threat led to the downgrade of government bond rating from AAA+ to AAA, the first ever such downgrade in the history of the country. That ugly debate shook up the business confidence and put brakes on economic recovery. Republicans ultimately lost that debate and they were forced to give in on tax increases for the super rich. Republicans’ intransigence, however, led to their poor performance in the 2012 elections. Now they are threatening to make the same mistake again.

Recent reports show that the federal budget deficit will fall to $759 billion for the fiscal year that ends this September, a $214 billion improvement from the projection made just a few months ago. Bi-partisan agreements on spending cuts and tax increases for the rich combined with improving economy are having a positive impact on the budget deficit outlook. If these trends continue, the issue of spending cuts, strongly favored by Republicans, may lose traction among the voters. As Obama correctly articulated in his recent speech on economy, given that corporate profits have surged to the record levels and budget deficit is declining, the government focus should now be on reducing unemployment rate which is still too high. That means the government should formulate policies that foster growth rather than be obsessed with spending cuts.

Congressional Republicans should start thinking about positioning themselves for the next election cycle of 2014, which is not that far away. Below is a laundry list of what Republicans should do:

• Reform the tax code. There is sufficient bi-partisan support for simplifying the tax code (by eliminating the special-interest deductions and rebates) and bringing down the overall tax rate for businesses. A lower overall tax rate would be very conducive to economic growth.

• Revisit sequestration and come up with more balanced bi-partisan approaches to spending cuts and individual tax increases. Some of the spending cuts triggered by sequestration (e.g., defense and Head Start program) are actually harmful and should be reversed.

• Given the dire state of our bridges, tunnels, and highways, we need to spend more on infrastructure improvements. A majority of people would have no problem with a special surcharge on gasoline to pay for these infrastructure upgrades.

• Education has been on the decline for a few years now and we need to do more to stay competitive in global trade. We need to provide more funding for pre-school and technical vocational training programs as well as find ways to reduce the rate of increase in the cost of college education.

Republicans need to demonstrate that they can be trusted to govern by becoming a part of the solution rather than being identified as a part of the problem. The Washington, DC gridlock only works against Republicans. If they can work in a bi-partisan way, their position will only become stronger by the time of the 2014 election.

DJIA down 550 points – Hysterical reaction by investors to Federal Reserve policy creates a huge buying opportunity

Posted by Shyam Moondra

The DJIA has gone down by 550 points in just two days, the largest two-day decline this year. Last Wednesday, Federal Reserve announced that, for now, they would continue to buy mortgage-based securities and Treasuries at the rate of $85 billion a month; however, the Fed also said that they were prepared to phase-out the QE program later this year if the unemployment rate fell to around 7% from the current 7.6%. The Fed announcement also pushed the yield on 10-year Treasuries to 2.42%, the highest since 2011. The announcement was hardly a breaking-news; everybody understood that if economy strengthened, the Fed would phase-out QE to ensure that inflationary expectations did not get out of control. It's almost as if the investors had already decided to dump both stocks and bonds regardless of what the Fed said. The expiration of stock options this week may have also contributed to this unexpected market crash. Interestingly, gold, silver, and oil prices also crashed, suggesting a total panic among the investors. They would rather hold on to cash and earn close to zero interest or less than the inflation rate, thereby losing ground in terms of real value.

When faint-hearted investors panic, smart investors aggressively move in and start buying good quality stocks at fire-sale prices. The crowd is so much focused on the tapering of QE and rising interest rates that they are completely ignoring the reasons behind the Fed's QE policy. As the Fed Chairman Ben Bernanke explained in his press conference on Wednesday, if the Fed started to taper off QE it would be because of improving underlying fundamentals of economy. An improved economy means higher sales and profits for corporations and that, in turn, means higher stock prices. Since corporate balance sheets are the strongest ever (with the current cash hoard of $5 trillion), they don't really need to borrow much to support their capital investment programs and are thus relatively unaffected by higher interest rates. Also, as Bernanke pointed out at his press conference, increase in mortgage interest rates would not necessarily reduce the demand for housing because the increase in monthly payments would be relatively small. Let's not forget that the current levels of interest rates are no where near the normalized levels that existed before the 2008 financial crisis. Therefore, investors' worries over increasing interest rates are somewhat overblown.

The current stock valuations are very attractive. The WSJ reports that the current estimates of forward PE for DJIA is 13.62, S&P 500 is 14.88, and NASDAQ is 16.22. It's hard to imagine a huge selloff at such low PE ratios at a time when economy is strengthening. If economy continues to improve, as the Fed expects, corporate profits will also increase and these estimates of PE's could in fact prove to be too conservative. At previous market peaks, we have had PE ratios in the high 20's to low 30's range. While no one expects that we would get back to those levels any time soon, the current PE ratios are hardly excessive to have triggered a huge selloff.

This is the time to buy stocks of high quality companies that are positioned to experience growth in revenues and profits as the economy improves. The current market crash may have created one of those rare opportunities for the long-term investors who tend to buy and hold stocks. Also, as the interest rates rise, the bond bubble will finally burst and some of the bond money will end up in equity funds, creating one of the greatest rotations of recent times. In fact, the DJIA could very well hit 18,000 within a couple of years.

This is not the time to panic - this is the time to buy quality equities for the long-term.

Rapid economic recovery may be the nightmare scenario for Federal Reserve

Posted by Shyam Moondra

On May 22, 2013, in a congressional testimony, Federal Reserve Chairman Ben Bernanke talked about the possibility of winding down Quantitative Easing (QE) in the next few months which caused the stock market to crash by more than 250 points. This flash crash makes the Fed acutely aware that their biggest challenge now is to flawlessly execute on the question of when and how to end QE.

With the congressional gridlock preventing the government from taking effective actions on the fiscal front to stimulate economy, the Federal Reserve came up with the idea of increasing liquidity via the so-called QE program. On December 16, 2008, the Fed announced that it would purchase up to $600 billion worth of mortgage-backed securities (MBS) and agency debt. On March 18, 2009, the Fed expanded the program by additional $750 billion. The idea behind QE was to push the long-term interest rates down to give a boost to the housing recovery and steer the investors towards more risky investments such as stocks that were being shunned by investors in the aftermath of the financial crisis of 2008. The thinking was that if housing prices recovered and stock prices went up, the wealth effect would lead to higher consumer spending. Since consumer spending accounts for 70% of the U.S. economy, it was thought that asset appreciation would increase the pace of economic recovery. When the Fed started its unprecedented QE program, the biggest fear was that significant increase in money supply over a short period of time could fuel inflationary expectations and bring the economic recovery to scratching halt. Since such a daring experiment had never been undertaken before, no one really knew what unintended consequences might result from QE. However, given the gridlock in Washington, DC, the Fed had no other choice but to find a way to infuse large amounts of funds into the monetary system to stimulate economic growth.

After the initial QE, however, the pace of economic recovery continued to be sluggish. The Fed doubled down and initiated QE2, which involved the purchase of long-term Treasuries at the rate of $75 billion a month over the period from November, 2010 to June, 2011. In September, 2011, QE2 was followed by the Operation Twist, which involved the purchase of $400 billion (later expanded by additional $267 billion) worth of bonds with maturities of 6 to 30 years and to sell bonds with maturities of less than 3 years, thereby extending the average maturity of the Fed's own portfolio. This was an attempt to do what QE tried to do, without printing more money and without expanding the Fed's balance sheet, thereby hopefully avoiding the inflationary pressure associated with QE. On September 13, 2012, the Fed announced a third round of quantitative easing, QE3. This new round provided for an open-ended commitment to purchase $40 billion worth of MBS per month until the labor market improved "substantially". The amount was later increased to $85 billion per month ($40 billion worth of MBS and $45 billion worth of Treasuries). Massive infusion of funds by the Fed into the monetary system finally did have the intended effect; the housing industry started to recover and the stock market zoomed up. The economy grew at a rate of just over 2% which helped create new jobs, albeit at a slower pace than desired, and the unemployment rate came down from 10 percent in 2008 to 7.5% in April, 2013. To the surprise of many economists (including some of the hawkish members of the Fed), inflation remained in check in spite of significant increase in money supply. In addition, QE inspired economic expansion, coupled with higher tax rates for the rich agreed to by President Barack Obama and Congressional Republicans, increased the tax receipts beyond what was expected. Higher tax receipts, in return, reduced the budget deficit to $642 billion (or 4% of GDP), about $200 billion lower than what the CBO had projected only three months ago. It is estimated that sequestration (across-the-board spending cuts) and QE could eventually bring down deficit to the level of 2.5% of GDP which is not considered excessive. The unanticipated large reduction in projected budget deficit has completely changed the dynamics of the gridlock in the Congress on the question of deficit/debt. With the sequestration in effect and Fed’s QE improving economy, the pressure is off for doing a quick grand bargain. The Congress might now focus more on its long-term goal of reforming the tax code and entitlement programs.

The biggest challenge for the Fed now is to decide when and how fast to terminate QE. It’s clear that if economy strengthens to the level of 4% GDP growth rate, the continuation of QE at its present level would most likely increase the inflationary pressures and force the Fed to stop QE in a hurry which could trigger rapid increase in interest rates and destabilize the financial markets. On the other hand, if economy continues to expand at the slow pace of 2.5% to 3% (at a cost of sluggish reduction in unemployment rate, of course), the Fed could devise a plan to gradually reduce the QE amount and eventually start selling MBS and Treasuries to bring down its balance sheet to more traditional levels. The QE disengagement has to be done slowly over a period of couple of years to have minimum destabilization effect on the financial markets. Bernanke was right in refusing to give in on the demands by some conservatives in Congress to terminate QE immediately. If economy continues at its present trajectory, the Fed may still have at least six months before beginning the phase-out of QE and completely unwinding QE by the time GDP growth rate hits 4% rate or unemployment rate falls below 6%, whichever happens first.

Bernanke’s second term as the Chairman of Federal Reserve Board expires in January, 2014. I hope he stays on beyond January, 2014 to finish the job and to make sure that QE is phased-out at just the right time and at just the right pace to ensure soft landing.

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.

Sequestration – the last opportunity for Republicans to redeem themselves

Posted by Shyam Moondra

During 1995 and 1996, Congressional Republicans, under the leadership of Speaker Newt Gingrich, passed bills that would have severely cut spending in such areas as education, Medicare, environment, and public health (areas favored by Democrats) to tame the run away budget deficit caused primarily by tax cuts enacted by Republican President Ronald Reagan as part of his so-called “trickle-down” economics. Those partisan budget actions forced Democratic President Bill Clinton to veto the bills that led to government shutdowns for several weeks in the late 1995 and again in early 1996. The twin government shutdowns resulted in interruption of essential services, causing delays and hardship to the citizens. The public’s outrage led to Clinton’s victory in his re-election bid in 1996. During his second term, Clinton managed to increase taxes for the rich to reduce budget deficit in return for agreeing to reform the welfare programs and subsequently the economy took-off. The stock market set new records and the unemployment rate fell to 4.5%, which is considered as the lowest possible "full employment" rate. By the end of his second-term, Clinton not only balanced the budget but he left the office with a small budget surplus. Many historians consider the Clinton era as one of the most prosperous periods in the nation’s history. After the poor showing of Republicans in the mid-term elections of 1998, Gingrich was forced to resign as the Speaker of the House. Ultimately, Republicans lost the control of the House and Senate to Democrats.

One would think that Republicans learned their lesson and would not make the same mistake again. But, a decade later, Republicans’ extreme tactics on budget issues are backfiring on them, once again. In 2011, Republicans waged an ugly debate on extending the debt limit which resulted in the historic downgrade by rating agencies of the U.S. government securities from AAA to AA+. Then came the “fiscal cliff” (convergence of expiration of Bush tax-cuts and mandated spending cuts), which was avoided only when Republicans, at the last minute, blinked and agreed to tax rate increases for the rich (those making more than $500,000 a year) to seal a deal with Democratic President Barack Obama. The public’s disapproval of Republican tactics led to the re-election of Obama in 2012 and a net loss of seats for Republicans in the Senate and House. Now, Republicans are again engaged in extreme budget tactics via sequestration that are highly unlikely to produce any better results for them than last time.

Sequestration, agreed to by both Democrats and Republicans in 2012 as a way to avoid making hard compromises on tax and spending issues during the election season, involves across-the-board cuts in discretionary federal spending (entitlement programs such as Social Security, Medicare, and Medicaid are unaffected) amounting to $85 billion between March 1 and September 30 of this year (if these cuts are continued over a period of ten years, they would reduce the budget deficit by over $1 trillion). Both Republicans and Democrats have mixed feelings about these automatic cuts – Republicans are happy that sequestration would finally force the government to slim-down but they are also unhappy that these cuts would hit the Defense Department the severest, thereby negatively affecting national security, and that the entitlement programs are off-limit; Democrats are happy that sequestration would reduce the bloated budget for the Pentagon that they have been trying to cut down for years, but they are also unhappy that these automatic cuts would negatively affect many of their favorite programs such as Head Start. At the time when sequestration was agreed to, it was thought that both sides would find parts of these automatic cuts so drastic that they would never dare to carry out these cuts and perhaps be more amenable to compromises.

Sequestration may not produce hardship to the citizens immediately, but over the coming months as these cuts start biting, the people would begin to feel the pain (reduced federal services, canceled contracts, military base closings, and job furloughs and layoffs). The government has estimated that as many as 700,000 jobs would be lost and these cuts would reduce the GDP growth by at least 0.5%. When that happens, as the recent polls show, Republicans would face the wreath of public anger over their intransigence. With the 2014 mid-term election season beginning soon, it’s smart politics for Republicans to back off from their uncompromising positions. Unless Republicans soften their rigid ideology of “no new taxes” and they embrace a balanced approach to spending cuts and new tax revenues, as Obama and Congressional Democrats are advocating, they may end up repeating history and losing the control of the House in 2014. Then Obama and Congressional Democrats, with a firm control of the White House, Senate, and House, would be free to aggressively pursue their agenda on fiscal matters in the last two years of Obama’s second term.

The deficit is too big (caused by Bush's two costly wars, unnecessary tax cuts to the rich, and bank bailouts that became necessary because of lax regulations under Bush) to be remedied by spending cuts alone; new tax revenues would have to be part of the solution. When special deductions and exclusions enable rich people like Mitt Romney and billionaire Warren Buffett to pay only 13-20% in taxes, it raises the question of fairness. When tax loopholes, added to the tax code over the years at the behest of lobbyists of special interest groups, enable rich companies like GE, Google, Apple and Goldman Sachs to pay only 0 -10% in taxes, that’s a problem. Clearly, rich individuals and corporations are not paying their fair share of taxes. Closing tax loopholes and eliminating tax giveaways is not the same thing as increasing taxes. This is more about cutting tax expenditures that we can’t afford.

If Republicans work cooperatively with Obama and Congressional Democrats in resolving the sequestration, they might improve their chances of winning the 2014 Congressional elections as well as the next presidential election in 2016. The sequestration, which no one likes, is the last opportunity for Republicans to repair their shattered image caused by their serial manufactured fiscal crises. Obama has already offered to put on the table entitlement reforms (that Republicans want) in return for higher tax revenues via tax reforms (that Democrats want). Several bipartisan groups, including the commission on deficit and debt led by Erskine B. Bowles and Alan K. Simpson, have called for one dollar of tax increase for every $2-3 of spending cuts. If Republicans and Democrats work together over the next few weeks and come up with a grand plan which would replace sequestration with a more balanced mix of spending cuts in discretionary as well as entitlement programs and fair tax reforms with a net increase in tax revenues, the country would be set for a sustained recovery for the long-term with millions of new jobs created. This is what an overwhelming majority of people want and this is what will restore the good image of the Grand Old Party.

If Republicans fail to seize this last opportunity that sequestration has presented to them for redeeming themselves, the consolation prize for the people would be that if the “fiscal cliff” and sequestration agreements on spending cuts and tax increases are carried out in full, the budget deficit would be reduced by about $4 trillion over ten years. This level of austerity would certainly cause some hardship in the near-term, but it would also be a big leap in improving the long-term fiscal health of the country. Of course, a grand plan, which includes entitlement reforms and tax revenues, would put us on a path of stronger recovery sooner and everybody would win, including the Republicans.

Bull market continues – DJIA headed to record high this year

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.

Time of reckoning has come for Republicans – either do what the electorate wants or become irrelevant

Posted by Shyam Moondra

Republicans campaigned based on trickle-down economics and lost. Not only they failed to win the presidency, they also lost seats in the Senate and House of Representatives. Republicans pursued a policy agenda that defied voter preferences (e.g., voters overwhelmingly want rich people to pay higher taxes) and they paid a price. Now the “fiscal cliff” is looming on the horizon, which has the potential to crash the financial markets and decimate people’s 401(K) and IRA savings a second time in less than five years. If Republicans don’t change their strategy, they would lose big time in the 2014 Congressional elections. In 2014, Democrats will most likely control both the Senate and House, and President Barack Obama will be free to execute his agenda on taxes, deficit/debt, education, immigration, energy, health care, and entitlement programs in the final two years of his second-term. In a nutshell, Republican Party will become irrelevant. That means, Republicans are better off to negotiate the best deal they can get now. Obama won, so he deserves to have some leeway in executing his policies; that's what the voters said loudly in the election.

Republicans’ trickle-down economics favoring the rich is inconsistent with the evolving mix of the electorate in which non-whites, most of whom are low-income and middle-class families, are growing the fastest and have a big say in the final outcomes of democratic elections. Clearly, the Republicans need to be more inclusive, if they want to win elections; and that means, they need to modify their agenda and move away from the unproven assertions that what’s good for the rich is good for the country or that rich people are the job creators. The Republicans need to start becoming part of solutions rather than continue to boil the pot based on extreme ideologies that are not supported by the electorate. House Speaker John Boehner must work with Obama and Congressional Democrats to form a winning coalition of moderate Republicans and Democrats - that's the only viable way forward.

Effective January 1, 2013, all Bush tax cuts will expire, so will temporary payroll tax cuts that were advocated by Obama as a stimulus to the sagging economy, and there will be significant across-the-board spending cuts. These tax increases and spending cuts at a time when the economy is still trying to recover from the 2008 recession would decimate the economy and push it back into recession with unemployment rising to double-digits, again. This, so-called “fiscal cliff,” will crash the financial markets, wiping out the wealth created in the last few years. Also, if the country is pushed over the cliff, the debt rating of the U.S. government securities will be downgraded for the second time in a short period of two years, which will put the upward pressure on interest rates. Higher interest rates will increase the interest expense for the government, thereby widening the budget deficit even more. The costs of a “fiscal cliff” are too high to contemplate and both Republicans and Democrats owe it to the people to reach a compromise and avoid the catastrophe. Given that Republicans lost the election, they have the primary responsibility for reaching out to the Democrats and making the necessary compromises (especially on increasing revenues by making rich people pay higher taxes) well before the end of the year. The Democrats also bear the responsibility for reaching out to the Republicans in carving out compromises on reforming the entitlement programs.

The continuation of the present gridlock in Washington, DC would be very damaging to the people and to the national security. Obama and Congressional leaders need to resurrect Obama-Boehner’s grand plan of reducing the deficit by $4.5 trillion over ten years; they could use that as a starting point and make the necessary modifications to reflect today's political reality in the aftermath of the 2012 elections and get it passed by the Congress as soon as possible, preferably before the end of the year.

Outrageous ideas for speeding up economic recovery and job creation

Posted by Shyam Moondra

This Thursday, the Federal Reserve Board (FED) is likely to announce a new Quantitative Easing program (QE3) through which they will infuse liquidity into the monetary system, inducing investors to go after more risky assets rather than park their money in fixed-income instruments that they consider as safe haven in the present uncertain environment. The earlier similar programs (QE1 and QE2) have had some positive effect on economy but they provided only a temporary lift. What if the FED takes a different approach this time?

Here is a recap of where things stand right now:

• The stock prices are historically low with S&P 500 PE hovering at around little over 15. At the last market peak, it was over 30. When the market goes up, the investors feel wealthy and more secured about the future. That leads to their increased spending which fuels the economy.

• The housing prices are improving, but they are still very depressed from their historic averages. Higher housing prices have the same wealth effect as higher stock prices; homeowners start borrowing against home equity which leads to increased spending that boosts the economy.

• The corporations have the best balance sheets in a generation, hoarding cash of the order of $3 trillion. They are ready to invest in capital projects and hire more workers, but two things are holding them back: gridlock in the Congress that creates uncertainty (and corporations hate uncertainty) and tepid consumer spending.

• Having lost tons of money in the 2008-2009 market crash, the investors have parked their cash in government securities that pay almost no interest and corporate bonds that are barely keeping up with inflation. So what we have is a fixed-income bubble that would eventually burst, as all bubbles do.

Given the above facts, this is what we can do to increase the rate of economic recovery and speed up job creation:

• The voters need to take a decisive action in November and give control of all three government entities, the White House, the Senate, and the House of Representatives, to the same party so we can finally get rid of gridlock. Under Obama, we have made progress in terms of job creation from the depth of severe recession left by the former President George W. Bush (4.5 million new jobs created in the last 30 months compared with 2.6 million jobs lost in the final year of the Bush presidency). Obama has demonstrated that he is the absolute champion of the middle-class (that accounts for 70% of consumer spending) and protector of Medicare and Social Security safety-net programs. Therefore, the voters should put Democrats in charge of all three parts of the government. In the past, the voters preferred a divided government to have checks-and-balances and to avoid ideological domination by any single political party. However, in the current circumstances, getting rid of gridlock is much more important than worrying about ideological domination. In the absence of gridlock, the government will be able to swiftly move on tax reforms and adopt a long-term balanced plan to reduce federal budget deficit and debt.

• The FED has been buying treasuries and mortgage-based securities to infuse more liquidity into the system with the hope that investors would go for more risky assets such as equities. The FED actions have had limited success in achieving their goals and these actions have largely benefited the financial sector which is in much better shape today than it was in 2008. Therefore, may be the FED should buy equities instead of treasuries and mortgage-based securities to encourage the investors to move their money from less risky instruments to more risky equities. The previous government investment in equities by the Treasury Department under the bailout program TARP (e.g., in auto companies and financial companies) has produced good returns for the taxpayers; FED’s equity purchases now when the market prices are relatively low should prove to be profitable for the taxpayers as well as beneficial for the overall economy. The FED purchases of equities (they could buy the stocks in various indices such as Dow Jones, S&P 500, NASDAQ) will move the stock market up and create wealth. By the same token, the FED should snap up foreclosed properties (rather than buy mortgage-based securities that benefit only the banks) to reduce supply of homes and thus give a boost to the housing prices, thereby creating the wealth factor on that front as well. The Congress would have to revise the Federal Reserve Act authorizing the FED to buy equities and foreclosed properties and also increase funding for the FED so that it will have the necessary resources to effectively execute the plan of investing in equities and foreclosed properties.

• The FED has stated that it will keep interest rates close to zero at least through 2015. The idea was to nudge investors away from fixed-income securities and towards more risky assets and encourage corporations and consumers to borrow and spend. Unfortunately, the low interest rates are not having an appreciable stimulative effect on economy; corporations don't need to borrow much because of their huge cash pile and consumers are reluctant to borrow because they don't feel secured in the current economic environment with high unemployment rate. Also, the potential home buyers are putting off their real estate purchases thinking that interest rates will remain low for some time so it's better to just wait for lower real estate prices. Therefore, the FED’s low interest rate policy is actually having unintended negative impact on economy. May be the time has come for the FED to try a different tack and start increasing interest rates and force these waiting potential homeowners to start buying homes now which will have a big impact on job growth. Higher interest rates will also increase the spreads for banks that will allow them to make fatter profits and thus become financially more stronger than they are now.

Since the 2008 recession, we have had the slowest recovery on record. It’s time the voters and FED try different approaches to improve economy and create lots of jobs faster.

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)

Dow Jones Industrial Average headed to 11,000

Posted by Shyam Moondra

In the past few days, the stock market has been very volatile, up 200 points one day and then down 200 points the next day. Some of this volatility may have been caused by the year-end window-dressing by mutual and hedge funds whose fiscal year ends in October. The market had gone up quite a bit since it bottomed out last March, so it was inevitable that some investors would want to take profits and short sellers would move in aggressively to create a downward momentum.

There are people who think that the market correction of the last few days may in fact be an exceptional buying opportunity for the long-term. Some of the stocks, that did exceedingly well since March, have been hammered down in recent days by as much as 25%. The bulls point out the following positive trends that suggest that the market is headed much higher:
· The recent quarterly earning reports exceeded analyst expectation by a wide margin. Most companies increased their guidance for the future.
· The latest GDP report showed that the economy grew at a faster rate than anticipated.
· The corporations have strong balance sheets, hoarding a lot of cash to support future capital investments.
· The corporations did a marvelous job in managing their cost structure during the recession and they have never been more lean and mean. That means their profit margins will expand rapidly as the economy recovers.
· The inventories are at historically low levels, suggesting that the industrial production may move into a higher gear (even if demand does not increase significantly), which means more jobs down the road. Recent industrial production report, showing better than expected increase, supports that belief.
· The stimulus spending was back loaded; as much as $585 billions worth of stimulus still remains to be spent through 2010.
· The Federal Reserve Board has indicated that money supply will remain bountiful and interest rates will remain low for the foreseeable future. Historically, liquidity and low interest rates have always favored the stock market in general and the financial sector in particular.
· Weak dollar has enhanced competitiveness of multi-national corporations that will garner a bigger market share as the global economy recovers. Weak dollar is also helping to reduce the trade deficit.
· Recent labor force reductions have considerably improved productivity that will expand the profit margins of the corporations in the near future.
· Since the capacity utilization remains low and demand is still weak, inflation is not going to be a problem in the foreseeable future. This gives the Fed some flexibility to keep interest rates low at least until the second-half of 2010.
· Recent housing reports suggest that the housing market has bottomed out, as indicated by the recent increases in home sales and home prices.
· The consumers have done a much better job in controlling their spending and saving more during this recession than any other recession in the past. This bodes well for the economy because as soon as the economy picks up some speed, the consumers will be ready to start spending freely again.
· The stocks are by no means over-valued with the average forward PE ratio in the low 10's. Recent merger and acquisition activity and share buyback announcements (e.g., by IBM) affirm that equity valuations are very attractive.

The bears have their own reasons for being pessimistic for the near-term. They cite the following trends that make them cautious:
· The stock market has gone up over 50% since March, making it the largest up move in a short period ever. It should be kept in mind though that the market went down too much in March because of the fear that some of the biggest financial institutions could go bankrupt, causing a systemic breakdown of the entire financial sector. However, that never happened and we are past that possibility now. One could argue that the market should not have gone down so much in the first place, and, therefore, it's misleading to keep harping on the 50% appreciation. Had market not gone down as much as it did because of sheer panic, the resulting appreciation would have been quite modest and considered normal in the aftermath of a severe recession.
· The unemployment rate will remain high at least through 2011, making it a jobless recovery. High unemployment rate will keep consumer spending in check. Since consumer spending fuels two-third of the economy, we may not see a quick recovery from recession any time soon. The counter argument would be that, while it's true that the lagging employment indicator would be slow to recover, the consumers are not going to wait for full recovery before they start spending again. All they are waiting for are the signs of a recovery-trend which will become obvious within the next six months, a lot earlier than 2011.
· Recent government spending (e.g., stimulus package and bailouts) has significantly added to the federal debt and budget deficit is widening. This will eventually lead to higher interest rates, choking off the economic recovery. We should, however, note that as the recovery takes hold, treasury revenues will increase and the budget deficit will eventually abate. Nevertheless, President Obama and the Congress would have to come up with a credible plan to address the issue of debt and budget deficit through a combination of spending cuts and tax increases for the wealthy individuals and corporations (shutting down off-shore tax havens and closing tax loop-holes).
· Weak dollar will lead to higher inflation because imports will become expensive which, in turn, will induce the domestic producers to increase their prices.
· The credit card losses and commercial real estate losses will keep the financial sector under pressure for the foreseeable future.

The stock market always looks ahead and most economic indicators (GDP growth, corporate earnings, housing sales and prices, industrial production, etc.) point to economic recovery from the worst recession of our times. While the recovery may be erratic, its direction is not in dispute. Early this year, industrial production was declining which led to layoffs, which, in turn, led to lower consumer spending, and that led to lower corporate profits, thereby creating a downward spiral in which each economic calamity was feeding into the others. But now we are in the process of an upward spiral that will restore employment, corporate profits, and stock prices over time. While there are very few plausible hazards that could choke off the recovery, there are many more potential catalysts on the horizon that could in fact propel the stock markets to new yearly highs in the coming months. The Dow Jones Industrial Average at 11,000 before the end of 2009 is not a far fetched possibility. One thing unique about Americans is that they are driven by a sense of optimism and hope. They thrive in adverse conditions and turn calamity into opportunity.

President Obama's speech on health care was effective – the ball is now in the Congress' court

Posted by Shyam Moondra

President Obama did a good job in outlining his health care plan in an address to the joint session of the Congress last night. The speech was well crafted and effectively delivered. Now the ball is in the court of the Congress that must deliver the legislation by the end of the year.

Prior to this address to the Congress, Obama was steadily losing ground in terms of public opinion because of his aloofness from the legislative process that many viewed as exhibiting lack of leadership. Also, his inadequate engagement with the Congress led to a lot of misinformation propagated by those, primarily conservative Republicans, who wanted to kill the initiative altogether.

This is what I liked in Obama's speech:
1. He articulated clearly that something had to be done on health care this year or else the whole economy will suffer in the long-term.
2. For the first time, he talked about tort reform that is essential to stop over-prescription of tests and treatments. The doctors and hospitals tend to order excessive tests and treatments just to protect themselves from potential malpractice lawsuits. These excessive tests and treatments significantly add to the cost of health care. The trial lawyers, who contribute heavily to the Democratic Party, generally oppose any changes in the malpractice laws; therefore, it was significant that Obama brought it up in his speech.
3. His three examples of how the late Sen. Ted Kennedy partnered with the prominent Republican senators to pass health care laws for children were particularly effective. Those examples will sway the attitude of many moderate Republicans who will now work harder to pass the health care legislation this year.
4. He successfully laid to rest misunderstandings about "death panels," government plan coverage for abortions, and the government plan driving insurance companies out of business - conservative Republicans had been using these misunderstandings to drive the public opinion against the health care reforms.
5. The government option will be started in a limited way, accounting for less than 5% of the total population.
6. The reasons for making health care coverage mandatory (just as most states require all drivers to buy no-fault car insurance) were explained better than before.
7. The proposed plan will be paid for without adding to the budget deficit.
8. He stated that he was open to adopting any new innovative ideas, Republican or Democrat, to make his proposed plan better.

This is what I didn't like in Obama's speech:
1. He listed three main goals of his plan: reduce the ranks of uninsureds, stop insurance abuses, and reduce costs. During the campaign, he always emphasized reducing costs as the primary goal of reforms, which I thought was right on the mark. If health care costs are brought down, many uninsureds will be able to afford to buy insurance and thus the problem of uninsureds will go away over time.
2. His price tag for the plan, $900 billions over ten years, will continue to turn off conservative Republicans and Democrats, especially at a time when federal budget deficit is running at record levels. Most Americans think that any tax increases should be used to reduce budget deficit and not for starting a new entitlement program.

Overall, Obama's speech was very helpful to Americans in understanding clearly what he was proposing and why. I am very optimistic that his speech will prod Democrats and Republicans to work together and hammer out a health care reform bill before the end of this year. Should Congress fail to pass a health care bill this year, Republicans will be blamed for this failure and they will pay a price in the mid-term elections of 2010.