FYI | Sep 27 2017
By Peter Switzer, Switzer Super Report
This is why you can keep believing in this bull market!
My watching brief of the stock market and the economy, as well as all of the related markets and forces that drive shares from currency markets to government regulations to Donald Trump, still tells me that believing in this unusual bull market makes perfect sense.
When my wife and I go to London in December, we will be collecting on a bet I made with this country’s most celebrated doomsday merchants — Professor Steve Keen. He predicted a recession this year here and elsewhere and I put it to him that if he’s wrong he’ll have to take us out to the best Chinese restaurant in London — Hakkasan. This is going to hurt his hip-pocket but it will be less than the pain he and his ilk have imposed on those who believed him.
The bet was made before Donald Trump was made President, so anyone who bought Steve’s pessimistic line could have missed out on the 14% return stocks delivered over 2016-17. Sure, they have avoided the sideways trade since April but dividends and franking credits still should top what term deposits are paying.
Steve and his kind one day will be right again, as he was in 2008, but let’s look at the stocks pay-off over one calendar year to understand what being too negative too early actually ended up costing.
On a year-to-date basis, we’ve gone from 4990 to the current level of 5682 on the S&P/ASX 200 Index. That’s a 13% gain before we think about dividends and franking credits. And in April we were up close to 19% when we crept up to 5924.
The market has never believed Steve’s story this year, with worldwide economies growing in synchronisation for the first time in a decade. This has underpinned a big recovery in stocks in Europe, while the S&P 500 Index is up close to 11% as it continues to break into record territory.
Doubters have been pondering how long the US market can keep breaking record highs. Back in June, Todd Gordon from TradingAnalysis.com saw the current 2500-level as the next top for this critically important for worldwide stocks.
In June, the Index was at 2400 and this is what he said then:
“We see a pending top in the market in the next three to six months, and at that point the fundamentals will confirm [the market’s price action] as the Fed begins to wind down the size of the balance sheet, drain some liquidity from the system, and that’s what will eventually confirm what the price action has already told us.”
That crucial Index has now been at 2502.
Of course, this doesn’t mean the US stock market will have to sell off but it might struggle to go higher until a new catalyst for optimism on stocks comes along. Like what?
Well, Donald Trump getting a tax win would do the trick.
Around this time, Mark Tepper of Strategic Wealth Partners in the USA was a believer that the US market was trending higher but he did tell CNBC that, “he would become more defensive in his positions if he were to see more aggressive tightening from the Fed, or if profits were to come under pressure. But he still forecasts earnings will continue to accelerate into the beginning of next year.”
Right now there are no worries on the US profits front and the Fed is starting to tighten but it still promises caution.
He thinks higher rates and shrinking profits will be the warning signs he’ll be looking for, “but we are at least a year away from that,” Tepper said.
Note he said “at least” and I think he is being very cautious.
At home, economists are getting more confident on rate rises but someone like Paul Dales of Capital Economics told me last week on my TV show that he thinks the first rise will be late, wait for it, 2019!
HSBC’s Paul Bloxham is more bullish, thinking the first rise will be in the first quarter next year, while the ANZ and NAB think it will be mid-year, with two hikes on the agenda.
And interest rates are the key part of the story on my view on stocks but don’t just accept my view. Hamish Douglass, the co-founder of the Magellan Financial Group is playing stocks at least for two years with confidence, based on where interest rates are.
Because rates are historically low, he argues, we can buy quality companies with higher price earnings ratios than we’re used to. I was brought up thinking a P/E of 20 compared to a 5% return on a safe term deposit, so when P/Es went into the 20s, it was time to ask: “Can this company justify this share price to earnings number?”
So as rates rise, I’ll become more cautious, but I must throw in that Westpac’s Bill Evans still expects there will be no change to interest rates next year.
Interestingly, Paul Dales thinks concerns about house prices might be based on our historical attitude to house prices based on interest rates.
Even though Dales thinks Sydney and Melbourne house prices are 30% overvalued, he says prices won’t fall until interest rates trend higher.
Anyone worried about a housing collapse that could rattle the economy and stocks should look at Paul’s thinking on the subject. He says residential debt to the value of housing is $1.6 trillion compared to $6.7 trillion.
Those who stress about the household debt to disposable income being at 200% ignore that debt servicing is the critical issue. And if rates stay lower for longer, then there’s less to worry about until that time.
Like Hamish, Dales looks at the P/E on housing and compares it to a very low interest rate. He calculates the P/E on housing in capital cities is now 5.8 compared to a historical 3.6, but you have to look at 5.8 in relation to the very low interest rates that now prevail.
Interestingly, Phil Baker in the AFR looked at Dales’ analysis and added in what the Reserve Bank’s assistant governor Luci Ellis said last week. If wages start to grow thanks to stronger economic growth, and disposable incomes continue to grow, then maybe house prices may not need to fall that much and the debt can be paid back quicker.
So we might not have to have a housing Armageddon but this does hinge on growth. If housing construction tails off as some predict, where does the growth come from?
Paul Bloxham thinks growth will come from lots of areas — exports, education, tourism, construction — residential albeit at lower levels than recently — and infrastructure.
The Weekend AFR’s Jacob Greber picked up on what I’ve been saying for some time that spending on roads, urbanization, etc. will deliver strong growth in coming years and not just here but worldwide. This is going to be good for our iron ore producers because steel is the foundation of most infrastructure projects
But this is the figure I love — “infrastructure spending is likely to be comparable or larger than what was invested during the resources boom of the past 15 years,” said CommSec’s chief economist, Craig James.
He actually calculates it to be one and a half times bigger than the mining boom!
Provided Donald Trump and Kim Jong-un don’t ruin it with fear and anxiety, this economic story has to underpin growth, bigger pay rises, grater consumer confidence, higher profits and better share prices.
Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.
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