The following is the weekly market commentary of David Kelly, the chief market strategist at JPMorgan Funds, for the week of September 27.
Last week the U.S. stock market rose for the fourth week in a row. The S&P500 is now up 9.5% from August 30th and up 70% from its March 2009 low of 677. While this end of summer rally is welcome, in this age of skepicism, many will wonder if anything in the investment environment really justifies it.
At its most basic level, the value of a stock should equal the discounted, after-tax earnings which will accrue to the owner over time. In other words, stocks should depend on interest rates, taxes and earnings.
On the interest rate front, the FOMC last week made it clear that while it has no plans to implement a new round of quantitative easing at this time, it regards the inflation rate as being undesirably low and stands ready to act if circumstances warrant. The bond market generally reacted positively to this with 10-yr Treasury yields falling over the week to end at 2.62%. Corporate bonds also rallied with the BAA yield falling to 5.60% on Thursday which is close to its lowest yield in over 40 years. For stocks, the long-term interest rates used to discount future cash flows remain generously low.
On the taxation front, there has been little change in recent weeks. Washington is in full election mode and compromise is not in the air. However, after the election, particularly if the Republicans capture the House of Representatives, there is a reasonable chance that the tax rates on dividends and capital gains will be maintained at low levels even for upper income individuals, a crucial consideration in valuing stocks.
With regard to earnings, the news has been generally positive. A month ago, many voices were predicting a double-dip recession. Today, after recently better numbers on international trade, inventories, capital goods orders and unemployment claims, fewer analysts seem to believe such a slump is likely. To be sure, the economy is far from booming, generating just enough economic growth to add some jobs but not enough to bring the unemployment rate down. Nor does it appear that growth is about to accelerate. However, it should be borne in mind that this mediocre recovery has already produced a more than 50% surge in S&P500 operating earnings over the past year and looks capable of driving earnings to an all-time high by some time next year.
Currently, the S&P500 is trading at 12.7 times the earnings expected by analysts for the next 12 months, well below the 16.6 times which this ratio has averaged since 1993. While it can be argued that not enough has changed in the last month to justify an almost 10% rise in stock prices, it is harder to contend that the stock market at these levels is anything but cheap.
Numbers due out this week probably won’t change any minds on either the direction of the economy or the valuation of the stock market. Measures of Consumer Confidence on Tuesday and Consumer Sentiment on Friday could both tick up a little, reflecting stock market gains, but will remain at very low levels due to still very high unemployment.
Thursday’s final read on second quarter GDP will rightly be ignored by markets as old news. However, good gains in August Personal Income and Spending due out on Friday should bolster growing hopes that output has been rising faster in the third quarter than in the second. Unemployment Claims will have an impact on investor sentiment as might the Chicago and National surveys of Manufacturing Activity due out on Thursday and Friday respectively.
However, perhaps the most significant data this week will be Auto Sales which will be released during the day on Friday. Economic data last week were dominated by August housing numbers, which, while abysmally low, were generally up from July. September auto sales could show a similar pattern. Less than 12 million units annualized is an extremely low level for light-vehicle sales. However, as is the case for home-building, from these levels it is much easier to envision a steady upward trend bolstering the economic recovery than a downward move detracting from it.
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