Relief, Rally Or Reality Rally?
Our House of Representatives brought the nation and the global economy to the brink of disaster and passed a stopgap measure with a day or so to spare. The preceding shutdown of the federal government cost the economy billions. Nothing seems to have been gained. Some or the business losses will be recovered but a great deal depends upon the seasonal strength of retail sales.
Holiday shopping should be strong if American consumers pick up the pace with anything like the vigor shown by stock market investors. As we approach Halloween, no one knows if the buying that sent the S&P to a new high is a relief rally from ghosts suddenly disappearing or a resurgence of optimistic “animal spirits.”
There are a number of factors supporting a continuing rise in stock prices, at least for the short term. The setbacks generated from Washington over the last two years, beginning with tax cuts, spending decreases and the mechanistic “sequestration,” put a foot on the brakes of economic recovery. Fortunately, the American economy is so strongly structured that it has been leading the rest of the world in restoring the momentum lost with the financial crisis in 1988.
The memories of those difficult times have not yet faded, one reason that overall valuations on stocks are reasonable. Stock fundamentals begin with earnings and corporate earnings remain at record levels. The recovery is still painful for the millions of unemployed, who will probably need revived stimulus spending.
For those fortunate enough to be stock investors, the combination of rising earnings with still mostly moderate valuations is encouraging. Low interest rates boost corporate earnings and encourage spending by businesses for new equipment and other capital assets. Acknowledging the impact of political battling on the economy, the Federal Reserve postponed tightening of its easy money policies until 2014.
These factors are all favorable for stocks. They have not gone unnoticed and the market has been on a tear since the collapse of the global economy was postponed until at least early 2014, when the extensions of the “debt ceiling“ and related matters expire.
Investors must not lose sight of these potential renewed political crises and should continue to emphasize strong companies with solid growth prospects. Interest rates will at some point begin heading back toward historic levels. These coming increases will begin to pinch indebted companies like many utilities and REIT’s. Bonds, particularly long-term bonds will suffer.
Another current favorable factor is the low rates of inflation. This factor has kept back the gains of asset-based companies like big oil, real estate and gold. Current conditions favor advanced companies with intellectual assets producing new ideas in technology, biotechnology and pharmaceuticals.
Google (GOOG-$1025) is a leading example. Its recent earnings knocked estimates through the roof and the stock went up over a hundred points in one day.
Apple (AAPL-$531) is another. Analysts forgot that the company is quite capable of producing innovative, attractive products and seemed surprised when it did. This is an extraordinarily cash-rich company with an enormous base of customers. Among other things, it collects billions of dollars in fees on the increasing number of “apps” bought for its ecosystem of iPhones and iPads. Holiday sales of its new products will probably be strong.
These two were not alone. Generac (GNRC-$47), Celgene (CELG-$157), Illumina (ILMN-$92), Novo-Nordisk (NVO-$182), Precision Cast Products (PCP-$256) and General Electric (GE-$25) all came through nicely. Like Apple and Google, they would enhance any stock portfolio.
With earning slowing, I sold Chevron and added a Chinese company to our flock with CNOOC (CEO-$196). The initials stand for China National Offshore Oil Corporation. Its properties lie in all the world’s oceans with particular strength in the South and East China Seas. China’s stocks wobbled recently and CNOOC now sells for less than nine times estimated 2013 earnings. It pays dividends, currently at a 3% rate.
The bounce back from the Congress crisis is much stronger than the usual reaction. This shows underlying momentum. Vigilance and an unemotional approach should yield further gains for the next few weeks.
Tony Crowell manages stock portfolios for individuals and their trust and retirement accounts with CROWELL•ROBERTS Investment Counsel, a registered investment advisor in Laguna Beach since 1993. firstname.lastname@example.org 949.494.1376/