The S&P Hits 2000
Why is the market moving slowly ahead when so many naysayers are calling for a crash, and when so many trouble spots are festering in the world?
We all see the fighting — problems in Syria, Iraq, Gaza, Ukraine, Libya — and we note that things are not going well for the freedom and security of many of the world’s people. We see Europe’s economy slowing down, and fears about a European banking crisis.
In spite of this, there is continued growth in the U.S. stock market. Why?
There is a lot of money and liquidity in the world economic system trying to find a home that pays a secureor fairly secure return.
Central bank quantitative easing (QE) and loosening bank credit in many countries has filled the world with liquidity — cash and loans are available to investors and speculators.
This cash and inexpensive borrowed money is looking for a place where it can make a return that stays ahead of inflation and offers more than the pathetically small return on bank deposits and short maturity debt.
To get a satisfactory return, investors are taking two courses of action:
First, they are buying debt, but longer-maturity or lower-quality debt; or
Second, they are buying stocks which provide income and the opportunity for growth of income and capital appreciation.
Let’s start with the first.
We view this alternative — buying longer-maturity or lower-quality debt — as extremely risky, and believe
that it is a dangerous course of action.
Why? Today the world has very low interest rates and low inflation. We have all seen that interest rates and inflation rise and fall in cycles, and the bottom of a multi-year low in interest rates seems to us an extremely risky time to buy longer-maturity debt. Interest rates in the U.S. and abroad are usually low only when demand for money is low and business activity is low and falling.
As we have pointed out in many recent letters, recent economic data from the U.S. clearly indicate that business activity in the U.S. is strengthening. Business is also strengthening in Asia, including China, India, and the emerging countries of southeast Asia. Japan is growing, but its growth is erratic.
Stronger global business activity will lead to higher inflation and higher interest rates. Economic cycles come and go. In 50 years as an analyst and money manager, this writer has seen many cycles. Today interest rates are near the bottom of their cycle. Buying when the cycle is near its bottom (interest rates today) or its peak (bond prices today) is a very common behavior. But it is a very unwise behavior for making and protecting one’s capital.
In summary, we would avoid making new commitments to bonds at this time. The second alternative — buying income-providing stocks with the potential for that income to grow, as well as to provide capital appreciation — is what we at GIM favor.
We believe that there are many dividend-paying, well-run companies that can grow their dividends over the coming years, and which we believe can also provide capital appreciation for investors. We monitor these companies, and speak to their managements; we understand the global economic, social, and political headwinds or tailwinds they experience, and grasp their financial statements and their financial outlook from both a macro (economic) and micro (company-specific) level. We continue to be enthusiastic about the income-producing stocks of quality companies.
Our goals are congruent with our clients’ goals. We buy these stocks for clients and for ourselves, although we are always careful to see that the client buys first or at a lower price and sells first or at a higher price.
Today’s market is filled with liquidity, which often eventually leads to bubbles. One reason today the market continues higher is that the options for investors are primarily in real estate or in stocks — while bonds have little yield, and commodities are low-priced due to a surplus of production in many areas (especially food commodities). Thus money is being driven into stocks and real estate, and that is why the U.S. stock market continues to march higher in the face of economic and geopolitical turmoil abroad.
