Olympic Rally or the Real McCoy?

Back in early June, I posted Yogi Berra – as good an investment strategist as any! in which I suggested :

“If financial turmoil continues unabated and rates remain extremely low, things could go very well for the stock markets, especially if earnings growth were to surprise on the upside….”

Well, here we are.  It began in earnest when companies like Intel and Honeywell began reporting earnings in excess of ridiculously low estimates.  Here’s a quote from Bloomberg today:

Equity futures advanced as investors watched second-quarter corporate results. Earnings at 71 percent of the 196 S&P 500 companies which reported results so far have beaten analysts estimates, according to data compiled by Bloomberg.    Demand for new U.S. homes climbed in June to the highest level in two years, economists project a report today will show.

Whenever consumer confidence falls as it did this summer, and the consensus is that things can only get worse, it’s almost always a good time to put money to work.  See my commentary posted in August 2011 called Consumer – lower confidence is GOOD news!

Rates have indeed remained low.  It does worry me that the consensus is steady low rates forever, which of course is impossible.  But bonds have actually rallied (rates got lower) in recent months and – as I suggested in June – there’s not much enthusiasm for  policy-makers to increase interest rates with unemployment (at 8.2%) so stubbornly high in the U.S. and Europe’s financial system under constant duress.

Finally we’re seeing what should’ve been expected – a marked improvement in profitability thanks to continued stimulus from easy credit.  The resilience of earnings is not hard to underestimate.  Consider what occured in 2011:

New York, January 4, 2012 – S&P Indices announced today that dividend increases reached $50.2 billion in 2011, an 89.2% rise over the $26.5 billion in dividend increases posted in 2010. For the full year, S&P Indices reported 1,953 dividend increases – a 13.0% jump over the 1,729 dividend increases reported in 2010. Only 101 companies, of the approximately 7,000 publicly that report dividend information, decreased their dividend in 2011 versus 145 in 2010.

Is the recent but modest strength in the stock market just a blip caused by a global  Kumbaya lift in spirits – a reaction to the 2012 Olympics?  Or will the rally in earnings actual translate into higher stock prices?

I’ve mentioned in the past that if the discount rate were 5% then the S&P 500, based purely on earnings, should be nearly 50% higher than it actually is today. 

The benchmark 10-year yield rose three basis points, or 0.03 percentage point, to 1.42 percent at 8:52 a.m. in New York, according to Bloomberg Bond Trader prices.

The discount rate we use should be at a premium to compensate for the added risk in equities, but with 10-year Treasuries less than 1.5%, the Prime Rate in the U.S. only 3.25% and 30 year mortgages hovering at 3.5% isn’t 5% (a >40% premium to mortgages) reasonable?

Just like an event in the Olympics, we won’t know for sure until the race is over.  By then it will be too late to place your bets.  Speaking of races, my friend and one of the best lawyers in Canada, Mr. Jeff Glass ran the 1984 Olympic 110 hurdles final – here’s the footage.  Behind all the others, he still managed to end up the 8th fastest hurdler….in the world.  No small accomplishment in my books.

Finally, an outstanding professional photographer (I’ve know him for a decade) Teddy Melvin, has office space next to me.  I said: “You seem busy today.”

Teddy: “I don’t know, suddenly I’m really busy. It seems it just fell from the sky.”

It must be bullish when the financial community feels confident enough to get pictures taken.  He made this ugly mug of mine look more professional I think….remarkable eh?

About Mal Spooner

Malvin Spooner is a veteran money manager, former CEO of award-winning investment fund management boutique he founded. He recently authored A Maverick Investor's Guidebook which blends his experience touring across the heartland in the United States with valuable investing tips and stories. He has been quoted and published for many years in business journals, newspapers and has been featured on many television programs over his career. An avid motorcycle enthusiast, and known across Canada as a part-time musician performing rock ‘n’ roll for charity, Mal is known for his candour and non-traditional (‘maverick’) thinking when discussing financial markets. His previous book published by Insomniac Press — Resources Rock: How to Invest in the Next Global Boom in Natural Resources which he authored with Pamela Clark — predicted the resources boom back in early 2004.
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