Three Things For The Bears To Reconsider
Despite the improving
picture for US equities, most market commentators
remain very skeptical about the sustainability of the three-month equity market
rally–mind you, they have been predicting lower stock prices since March 17 and
have continued to do so all the way up. These skeptics have been ignoring
positive fundamentals (such as the low cost of capital for consumers and
businesses; improving forward earnings; $350 billion in fiscal stimulus;
improving sentiment; lower debt servicing costs; and improving manufacturing
data) and instead, they continue to refer to low levels in the VIX index;Â
“anemic” corporate outlook; and a strong Treasury market as evidence for lower
equities. In my view, however, investors should assign little importance to the
arguments being made by the bear camp as there is plenty of evidence to
discredit these points of contention.
1. The Low VIX ArgumentÂ
For those of you who are unfamiliar with the VIX,
it is an index that measures the level of investor fear/complacency based on the
price of options contracts on the equity market. The index is currently at 21.70
(70 points above the 52 week lows in the index) and many pessimists believe that
these low levels indicate extreme market complacency. However, I’m sure that
investors would be interested to know that beginning in 1985, the
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remained below 21 for while the S&P climbed for 10 years, with the exception of
October 1987.
2. Tepid Corporate Argument
Admittedly, US businesses have been very cautious
about their outlook regarding hiring, demand, and investment. But this caution
needs to be taken with a grain of salt, as the current environment offers
business managers little upside to announcing optimism for business conditions,
despite the fact that fundamentals may be improving. Some of the factors
contributing to the difficult environment include a three year bear market;
corporate and investment banking malfeasance (Sarbanes-Oxley); plaintiffs
attorneys waiting for any excuse to file a class action suit; and unforeseen
negative events(9-11 and SARS). Investors would be better served by looking at
the improving trend in Capital expenditures from the trough in the third quarter
of last year; the heavy spending incentives in the current tax-cut plan signed
into law last week; and the recent spike in the orders component of the ISM and
Chicago PMI surveys.
3. Low Treasury Yields
Argument
Finally, naysayers continue to refer to the low
level of Treasury yields as a harbinger of more equity market pain. However,
during the final stages of an economic recession, it is not unusual for
Treasuries and equities to move higher. The reason is that stocks are forward
looking and tend to move higher at the end of recessionary periods as investors
purchase equities in anticipation of stronger growth to come — despite the lack
of confirmation in data releases, which are backward looking. At the same time,
Treasuries also move higher during this period as a result of falling inflation
— which is very common during the final stages of recession. In fact, during
the last three months of the last eight recessions, the S&P
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gained an average of 12.8%, while the yield on the 10-year note
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has dropped an average of 57 basis points (Treasury prices are inversely related
to their yields).
Although the last official recession ended in
December of 2001, when the economy contracted for two consecutive quarters, the
manufacturing sector has continued to contract, while the rest of the economy
has puttered along in a very anemic recovery — if you can call it that. As a
result, stocks and bonds are only now acting as though we are emerging from a
recession.