The Wild Blue Yonder
Off we go with all three major stock averages at or near record high levels. On some days, they form a trifecta with all three setting records. Their content differs. The popular Dow Industrial Average reflects changes in thirty selected blue chips, the S&P 500 Index a weighted average of the 500 largest companies and the Nasdaq Composite an index of over 3,000 issues on the NASDAQ market, which is heavily weighted toward technology stocks.
These simultaneous moves clearly reflect broad market participation. Another marker, the Dow Jones Transportation Average has been making record highs since July. A very old-school market indicator, the Dow Theory, calls for a bull market when “the Transports confirm the Industrials.” No market indicator is infallible as popular adherence would make it self-defeating but the Dow Theory’s previous major buy signal came in 2009 as the current eight-year bull market got underway.
Stock prices move in anticipation of future events and advancing stock prices forecast increasing corporate earnings. Fortunately, these are continuing, even accelerating as companies continue their recovery from the deep scars left from the 2007-2009 Recession. Stock prices will probably overshoot as they usually do, leading to an inevitable pause or even a correction of 10% or so. This eventual dip will be more damaging to overvalued stocks, thus portfolios should be reviewed and new purchases directed toward stocks with arguably reasonable Price/Earnings ratios.
The current PE on the S&P 500 is around 16. The 10-year adjusted PE ratio developed by Yale Professor (and Nobel Laureate) Robert Shiller is around 31, a high figure that is (ahem) about the same as it would have been in 1929. Dr. Shiller has emphasized that he still owns stock and that the Shiller PE was never intended as a short-term market indicator. Using the past 10 years of earnings as the dominator includes the years of depressed earnings during the Recession, thus the ratio will lower with time.
Earnings are beginning to come in for the third quarter, led by the big banks. JP Morgan Chase (JPM-$95) beat analyst estimates even though legislative reforms promised a year ago are yet to appear. Citigroup (C-$72) results were similar. The PE of JP Morgan Chase is a very reasonable 14 and its dividend yield is 2.3% with increases for the last six years.
These results reaffirm my repeated recommendation for Chase as well as for Bank of America (BAC-$25), who will report earnings tomorrow. All institutions ground their investment tactics on the benchmark U.S. Treasury 10-year bond. Its yield today is 2.3%, down slightly from 2.6% last December. For investors who are not shackled to buying bonds as some institutions are, the choice is clear.
Prevailing low interest rates seem destined to provide tail winds for stocks and other assets well into 2018 and possibly 2019 or 2020. I noted in last week’s column that Mr. Buffett said in a recent interview that if interest rates were 1% higher in three years, stocks would still be cheap. If rates are 3% or 4%, not so cheap.
Not even Federal Reserve members know where rates will be in three years but retiring Fed Vice-Chair Stanley Fischer said yesterday, “well, low interest rates stock-market prices will tend to be higher than they would be if the interest rates were higher. But we don’t think we’re in a situation where we have an inflationary bubble or an unsustainable set of prices in the asset market.”
Put another way, “There is a tide in the affairs of men, which taken at the flood, leads on to fortune. Omitted, all the voyage of their life is bound in shallows and in miseries. On such a full sea are we now afloat.” Julius Caesar Act 4, scene 3,
Apple (AAPL-$156), a continuing buy, has a PE of 17 with exceptionally strong finances and a unique competitive position. Nvidia (NVDA-$190) has muscled its way behind Apple to our #2 rank. It has a PE of 54, after rising 77% this year. The company’s earnings report next month will show it well on its way to dropping that PE with earnings growth over 20%. Amgen (AMGN-$182), the leading biotech, has a PE of 17. Its earnings growth has slowed with increasing size but its 2.5% yield with dividend bumps for five years is an example of the rewards from stocks “in the wild blue yonder.
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. [email protected] 949.494.1376/
800.697.2622 www.crowellroberts.com\\\\
