· Short term stock pullbacks provide buying opportunity
· Fed lowering interest rates and providing liquidity for asset purchases
· Cyclical industries and international stocks look undervalued
· Historically low bond yields are pushing income investors into dividend paying stocks
We are entering the fourth quarter of 2019, and we assume we are also entering the fourth quarter of the current bull market - but how much time is left is anyone’s guess. There are many reasons to predict the current expansion will continue, and conversely reasons to predict its end. Let’s start with the headwinds.
Political risk is distorting markets in the short term. We see daily stock market changes happening as a result of tweets and trade policy leaks. This is not helpful for businesses trying to make long term investment decisions. We have seen growth slow globally and domestic GDP estimates are hovering around 1.8-2.1% for 2019. This is coming off 2.8% in 2017 and 2.5% last year. Regarding policy, the effect of corporate tax cuts are accounted for in current growth estimates and stock prices. Secondly, most of the money saved in taxes went to share buybacks rather than production or efficiency upgrades. Additionally, the stock market is trading at about 16x earnings at the current tax rate. If taxes return to 35% that jumps to about 24x earnings and suddenly the market looks very expensive. On the jobs front, hiring looks like it might be peaking, and unemployment is about as low as it can go. However, the Fed is feeling pressured to cut rates further to keep inflation up around 2% and to stabilize the banking industry by providing liquidity amidst slowing growth. This Fed action may have the unintended consequence of actually slowing the economy this late in the economic cycle. Cutting rates to boost purchases doesn’t do as much in this current environment because borrowing costs are already extremely low. For example, due to asset inflation in the housing prices right now, the down payment cost and creditworthiness are the major hindrances, not rates; where down payment and creditworthiness is not much an issue like with medium sized purchases such as cars, TVs, furniture, etc., people are willing to wait for financing rates to get even cheaper if they see rates falling; those with savings accounts as their main or only nest egg are seeing their returns dwindle under lower rates; and lastly, the psychological impact of lowering rates will signal to people that the economy is not doing well and that in and of itself can become self-fulfilling.
Now let’s examine market tailwinds.
Just because the bull market is old does not mean it has an expiration date. Unemployment is at a 50-year low, the economy is still in expansion territory, and inflation is low and fairly steady. Monetary policy around the globe is in easing mode. This is providing ample cash for asset purchases including continued share buybacks on a massive scale ($940B for S&P 500 companies alone in 2019). Earnings are steadily growing, albeit slower than in previous years, but are not showing signs of retreating into negative territory (especially with share buybacks reducing the number of shares in the market, goosing up earnings per share numbers). Cyclical industries like financials and energy look to be undervalued and could provide outsized market returns if investors flock back in. Lots of cash rotated into defensive stocks too soon fearing a major industrial slowdown. An example of this can be seen in the utilities sector. Cash has poured into utilities over the last two years due to their traditionally “safe haven” position in tough markets providing high dividend yields. But now the utilities sector is about 60% overvalued relative to the rest of the market on a price to earnings comparison. International equities also look cheap on a historic basis and provide good dividends. Investors have been shying away from there for years. Another boon to dividend paying stocks is the dearth of income generated by bonds. With 10-year treasuries paying around 1.7%, investors are looking to quality equity names for their fixed income needs. Even 30-year corporate bonds are hovering around 3% interest, not to mention the explosion of negative interest-bearing bonds overseas. Do you want to lock up your money for 30 years and earn 1% above inflation at best or even lend $100 to get back $99, or do you want to take your chances in the stock or real-estate markets over that same time frame?
Bottom line: The Federal Reserve and its kind around the world are begging other governments, and investors big and small to borrow money and buy stuff.
We don’t know when the expansion will end or how deep the pull backs will be along the way, but this bull market looks like is has a bit more game to play before it’s over.