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The Great Rotation – Why It’s Time to Buy the Stock Market

Stock-Markets

Stock Markets 2014Jan 09, 2014 – 01:57 PM GMT

By: Money_Morning

Shah Gilani writes: Calling what we’re experiencing a bull market is like calling the Grand Canyon a ditch.

First of all, this rally – the one that sprung us from the depths of the Great Recession, and has pushed the S&P 500 170% above its 2009 low – has largely regained lost ground. This historic “rally” has taken the bellwether index just 265 points beyond its October 2007 peak.

In other words, 153 percentage points of the rally since 2009 were necessary just to get us back to 2007.

We’re up only a modest 17% from the old highs.

I wouldn’t call that overdone. I call that a leg to stand on. And it’s just the first leg.

This, as you’ll see, is a generational bull market…

We’re Not Overpriced, Even in a Record Market

The dividend yield on the S&P 500 back on Jan. 1, 2007, was 1.76%; as of Jan. 1, 2014, it was approximately 1.90%.

The benchmark’s trailing price earnings multiple at the 2007 peak was 17.5. Today it’s 19.

For some, perspective on whether today’s average PE is high is based on PEs from Jan. 1, 1980, through Jan. 1, 1990.

The 1980s PE averaged 11.89; the 1990s PE averaged 21.73.

And the 2000 through 2010 PE averaged 29.58, a period skewed by the Jan. 1, 2009 PE of 70.89.

But if we replace the January 2009 PE – essentially, an outlier – with the 1990s average of 21.73, the 2000 through 2010 average is much lower.

With that adjustment, the 1990 through 2010 average PE is 23.42. So today’s PE of 19 isn’t flashing any warning yellow lights.

According to Birinyi Associates and WSJ Market Data Group, the market capitalization of the S&P 500 at the old October 2007 peak was $13.8 trillion. It fell to $5.9 trillion at its 2009 low. Today it’s back up only slightly from the old peak to $13.9 trillion.

The whole market had a value of $20.9 trillion at the 2007 high and is up just 2% over the last six years to $21.4 trillion.

Whether you’re looking at relative price earnings multiples or weighing valuation metrics, stocks don’t appear to be overpriced or overvalued. In fact, they look poised to go higher, probably a lot higher.

Prices go higher when there are more buyers than sellers. But, there’s an even bigger dynamic at play than buyers and sellers – there’s the supply and demand equation.

More Equity Money and Fewer Equities Means Rising Prices

According to the World Federation of Exchanges, there were 9,000 companies listed on all U.S. exchanges in 1997. Today there are 5,000 listed companies; that’s a 40% drop.

The shrinking number of listed companies parallels the rise of giant and specialty private equity buyout shops who have been taking companies private. At the same time, the 2000 tech bubble bursting reduced the former flood of IPOs to less than a trickle over the past 13 years.

The low interest rate environment engineered by the Federal Reserve also allowed companies to borrow cheaply to buy back their own shares. That’s reduced supply too.

The combination of rising prices from companies buying back their own shares, more demand from sidelined investors coming into stocks as prices rise, and ever-larger pools of institutional investment capital chasing a considerably tighter supply of shares all lead to one thing: stocks to continue to rise.

With supply reduced, it won’t take a lot of additional demand to propel stocks higher.

And there’s good news on that horizon, too.

Fed Support Will Keep Banks, Housing Healthy

Big U.S. banks, courtesy of the Federal Reserve’s extraordinary efforts, have been cleaning up their balance sheets and are in better shape than they have been in years. All that’s left to do is for the Fed to manage a steepening of the yield curve, which they are. That will eventually raise rates on the longer end of the yield curve while they keep the low end at nearly zero.

How will that help stocks? Banks who borrow at rock-bottom rates will be inclined to lend more freely if they make longer-term loans at higher rates. This will increase their net interest margin and loan portfolio profits.

More consumer credit will lead to better consumer confidence, more spending, more production, and better earnings for companies. In other words, we’re looking at a reviving economy.

We’re already getting some good news on the consumer and the economy.

The Federal Reserve’s household-debt services and financial obligations ratio – which measures the ratio of debt, lease, rent, insurance, and property tax payments to disposable income, is 15.3%, down from 18.4% in 2007, and its lowest level since the 1980s.

And, Americans’ net worth, driven by a rising stock market and firming housing prices, has bounced up to $74.8 trillion in the second quarter of 2013 from its 2008 low of $57.2 trillion. That’s a healthy 31% increase.

And Here’s the Biggest Catalyst

Finally, there are lots of other positive metrics and future scenarios supporting a rising market. But I’ve saved the biggest catalyst for last in my analysis here: Low interest rates globally will result in a structural shift out of fixed-income investments into better-yielding equity opportunities.

This “Great Rotation,” as it’s been called, has only just begun. It will gain steam and propel U.S. and global equities higher for years to come.

Of course, just because the long-term prospects for equities are outstanding, it doesn’t mean markets won’t get “overbought” from time to time on a short-term basis. Profit-taking bouts, selloffs, panics, and corrections haven’t been outlawed. They will all be part of the landscape no matter how high stocks go.

That’s good news for more active traders, and market-timers, who can profit handsomely from volatility and market swings.

There are plenty of adept traders, investors, and institutions who will make huge sums playing these down moves as well as the long haul higher. Even buy-and-hold types can add to their long-term returns by allocating some capital to active managers who excel at this game.

They’ll be phenomenal moneymakers for experienced professionals smart enough and aggressive enough to add huge shorting gains to core longer-term long positions. If you can, allocate some money to them if you don’t know how to play from that side yourself.

Stocks bounced off their credit crisis lows and have been enjoying higher valuations as corporate balance sheets have been reengineered. Earnings have been more robust thanks to increased global trade over the past decade. Supply and demand dynamics have additionally been supporting rising prices, all without pricing and valuation metrics becoming overheated. That’s how we got to new highs.

But, it’s only the beginning. We’re just rounding up the last stages of this generational bull market’s first leg. There will be two more legs higher. So get into the game. You’ve got to be in it to win it…

Source : http://moneymorning.com/2014/01/09/time-buy-grand-canyon/

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