While some of the bears are starting to emerge from a long hibernation, MWG is still firmly in the camp of the bulls, despite the six year run being the fourth longest bull market in history. We expect the spring and summer to shed even more sunshine on the markets. Many market pundits continue to wag a foreboding finger about the cyclically adjusted price to earnings (CAPE) ratio, the Shiller-P/E, Tobin’s Q ratio, and other signs that signal a market top. We won’t bother to bore you with the details of these various metrics. According to Savita Subramanian, Equity Strategist at Bank of America Merrill Lynch, “When investment strategists have been this bearish in the past, the S&P 500 rose 98% of the time, with average gains of 27%.” While the markets are certainly richer than in the recent past, we believe there is significant room for greater share price appreciation. When the markets do check back (and they will), we would view that as a nice opportunity to buy.
Our work suggests there is no imminent end to the current bull market, despite the fear-mongering of some of the bears. First of all, interest rates remain low. In fact, in many countries, including Canada, interest rates have recently been cut yet again. In the US, the Federal Reserve remains undecided, but given recent jobs data, is unlikely to raise rates until late in 2015, and even at that, the pace of interest rate hikes needs to be relatively gradual to sustain the strong recovery. In today’s environment, consumers and businesses can borrow at near-record low interest rates, which should continue to stimulate the economy. Corporate balance sheets and profits remain strong. The bottom line is that investors looking to grow their portfolio in a low interest rate environment should still prefer equities. Simple supply and demand should dictate that share prices will continue to rise. And cash levels remain high, with the only home for it being equities, in our view.
Bond yields remain extremely low. Interestingly, nearly half of the S&P 500 pays a dividend yield above the 10-year treasury yield and the S&P 500 payout ratio currently resides close to century lows. There are about 60 companies in the S&P 500 with yields of 3.5% or greater, including AT&T, Verizon Communications, Philip Morris, Duke Energy, General Motors, General Electric, Caterpillar and many other well-known companies. For investors looking for yield, equities offer a great place to generate tax-efficient income through dividends.
Inflation has also been relatively benign. In fact, many economists have been more worried about deflation, compounded by low energy prices. Low pump prices are leaving more money in consumers’ jeans, prompting spending in other areas, like buying a big truck, going to a restaurant, travelling and other discretionary spending. Other industries and companies should benefit from much lower energy-related costs, e.g. airlines.
Governments around the world remain accommodating, taking the necessary steps to stimulate their country’s or region’s economy, e.g. EU quantitative easing to stimulate the European economy, through bond buybacks until the fall of 2016, following in the footsteps of the US’s successful efforts starting in 2009. This could certainly help EU exports as well. Other countries have worked hard as well, like Japan, China, India and Canada.
Finally, to frame it, the S&P 500 is trading at a forward P/E ratio of close to 17.5x. Yes it seems high. But frame it against other periods of time. Remember the Nifty Fifty of the early 1970s when large cap growth stocks such as Xerox, IBM, Polaroid, and Coca-Cola became institutional darlings given their strong growth records and continual increase in dividends. At the time, many investors did not seem to find the lofty forward multiples of 50, 80 or even upwards of 100 times earnings an unreasonable price to pay for the world’s leading growth companies. Many of the same Nifty Fifty stocks are best in class leaders today. The multiples paid back in 1972 are now considered a huge bargain when framed against the subsequent growth of these stocks, augmented by strong dividend increases. The lesson remains; buy and hold best-in-class names through time and ignore the market pundits.
We are in the midst of a broad market upswing as often happens during cyclical upturns, interest rates and inflation remain in check, consumers and businesses are in very good shape, and governments around the world are supportive. We continue to run with the bulls.