Popes, Politicians, and Bulls
Roman Catholic Cardinals met in secret to choose a new Pope to lead more than 1.2 billion followers. White smoke billowed from the Vatican chimney at 7:07 pm. Pope Francis was introduced to the world about 90 minutes later and offered prayers for all the people of the world. The entire election process lasted less than 48 hours. This is an amazingly efficient process.
Meanwhile, the U.S. Congress debates Paul Ryan's budget proposal. (Feel free to groan at will. But don't groan for long.) Bullish investors are brazenly driving share prices higher.
On Tuesday, March 12, on CNBC's The Kudlow Report, I found myself in the familiar role of voicing caution to bulls Jack Bouroudjian and Larry Kudlow. Jack began, "I am a bull, Larry. You buy every 3-5 percent dip. This is a breakout year." Then Larry said, "If you got 3 percent growth -- 3 -- I don't know that, but if you got 3 percent growth, the ten-year treasury will go to 2.5 percent, it might go to 3 percent and the market might stub its toe for 20 minutes but will rise along with it."
Jack Bouroudjian may be right. In 1994 the Dow Jones Industrial Average soared through 4,000, and in 1996 Alan Greenspan mentioned "irrational exuberance" as the Dow passed 6,000. Eight months later, it crossed 8,000. The underlying economics were different, but the awesome, inexplicable surge felt similar.
These were great years for most portfolios, but my TV appearances then were also cautionary. I said, "We won't buy stocks that don't have earnings." I also said, "I don't know what a 'concept' stock is, and I certainly don't know how to value one"; "85 percent of these dot-coms will not exist in five years"; and "Anything that can go up really fast can go down really fast."
Bull markets and bull market sentiment are powerful and mysterious. We have never experienced a market climb against the economic backdrop of endless Quantitative Easing and perennial trillion-dollar deficits. Maybe it will prove wildly successful for investors; indeed it has so far. Share prices are some 34 percent higher over the last 18 months and are up well over 100 percent since the market bottom in March, 2009.
When I invested clients' assets in a Large Cap Growth Composite in the late 1990's,they did well (Please see our full disclosure of our GIPS-compliant audited performance.), but I was called a "wet blanket who just didn't get it." As much as I'm enjoying market returns today, I'm again suffering from "I don't get it" puzzlement.
Retail sales data show that the U.S. consumer is incredibly resilient in the face of tax hikes and fiscal uncertainty. To assess the sustainability of robust consumer spending, we must look at both the consumer's willingness AND ability to continue spending. The consumer's willingness will likely be determined by his confidence in the economy, labor market, and government.
While Consumer Confidence (reported by the Confidence Board) is still well below the levels prior to the financial crisis, it has been trending steadily upward over the past several years and is close to five-year highs.
However, we suspect that the government's inability to address the problem of deficits, debt and entitlements will continue to weigh on the consumer's psyche. This will be a continued drag on spending going forward as there will be continued uncertainty about taxes in the future.
The consumer's ability to spend will be determined by the labor market, income levels, his financial condition, and access to credit. Most of these issues have improved in recent months. Home prices are up 6-7 percent from the lows of early 2012 (Case Shiller 20-Cityindex). Household net worth is up nearly $15 trillion from the lows of the financial crisis. Consumer credit is growing again after a period of contraction. The unemployment rate has come down to 7.7 percent as an increasing number of jobs is added each month.
However,a major concern is that the middle class consumer continues to see income decline (adjusted for inflation). According to the U.Ss Census Bureau,median household income in 2011 was at the lowest level since 1995. Meanwhile, the middle class consumer has seen the price of basic necessities (food, energy) rise dramatically over that time frame.
We continue to believe that the middle class is getting squeezed, and that a healthy and vibrant middle class will be the key to growing the economy over the longer term.
Were main cautious regarding the economic recovery until we see the kind of widespread job and income growth that can lead to sustainable increases in middle-income consumer spending over time.
Economic data are improving, and the fuel of government dollars continues in force. Earnings at S&P 500 companies are being generated at near peak margins, and the index is moving to all-time highs. Two sayings haunt me:buy low and sell high, and as Mae West said too much of a good thing can be wonderful!
If Jack Bouroudjian is correct, we can all rest easily and count our money…for a while. Timing the market doesn't work,so my caution or optimism doesn't change our allocations, but a keen focus on balance sheets, leverage, and earnings growth let's me sleep a bit easier. Viva il Papa!
Mr. Farr is a paid Contributor for CNBC television and has appeared on numerous broadcasts and has been quoted in global publications. He is a member of the Economic Club of Washington, DC, National Association for Business Economics, The World Presidents' Organization, and The Washington Association of Money Managers. He is the author of "A Million Is Not Enough," and "The Arrogance Cycle."
His new book, Restoring Our American Dream: The Best Investment, will be in book stores on March 30.