Newsletters 2010 Newsletters What Could Go Right? (1/10)
Friday, 15 January 2010 17:36
What a year 2009 proved to be. After the initial collapse during the first quarter, the stock market steadily rose throughout the balance of the year and finished 2009 with significant gains. The Dow Jones Industrial Average, S&P 500 Composite and NASDAQ Composite rose 18.82%, 23.45% and 43.89% respectively. We are very pleased to report that the composite of all managed equities at Osher Van de Voorde rose 28.80% in 2009.
In last month’s newsletter, we outlined our primary areas of concern as we embarked upon the New Year – growing deficits, higher taxes, a weakening dollar, an embattled U.S. consumer and the probability for conflict in Iran. We are tempted to add the potential for a double dip in the housing market and continued weakness in the commercial real estate market to this list. Despite these concerns and others still, we set our initial 2010 year-end price target range for the S&P 500 at between 1,200 to 1,280, which would equate to an approximate 8% to 15% move higher from the S&P’s 2009 close at 1,115. Since the market already knows all of these concerns only too well, this month we will temporarily suspend our disbelief, don once again our rose-colored glasses and imagine what could go right in 2010.
First, let’s review the most recent set of economic data that collectively point to a recovery that may be gathering momentum. Just released minutes from the Fed’s December meeting indicate that Bernanke and company are growing more confident in the economic recovery underway due to “better-than-expected data on employment, consumer spending, home sales, and industrial production”. Let’s look at each of these components:
Employment: Initial weekly jobless claims fell below 450,000 for the first time since August 2008, while continuous claims have fallen below 5 million for the first time since February 2009. The ADP jobs report revealed the smallest drop in total private sector jobs and estimated the first increase in private service sector employment since March 2008. Challenger Gray also announced that December layoffs were 10% lower than November and at the lowest level since December 2007. And the Bureau of Labor Statistics revealed a loss of 85,000 jobs for the month of December. While the BLS was mildly disappointing, November was revised higher and showed that 4,000 jobs were created versus the initial report that 11,000 jobs were lost. The recent surge in productivity suggests that companies are getting by without the need to ramp up hiring. We expect unemployment to remain stubbornly high throughout the year, which may serve to keep Fed rate hikes at bay and the Obama Administration especially nervous about midterm elections.
Consumer Spending: Retail sales rose by 1.3% in November, ahead of the .7% consensus. The momentum seemed to continue through December as retailers are generally reporting year-end sales ahead of Wall Street expectations. Even troubled U.S, auto companies are reporting surprisingly strong sales (post “cash for clunkers”) with Ford trouncing sales expectations and GM now forecasting a profit for the full year. And the December University of Michigan consumer sentiment index came in at 73.4, ahead of the 67.4 registered in November and the consensus for a 68.8 reading. With the savings rate now at 4.4% of disposable income, it is possible that the consumer has found a “new normal” balance between saving and spending.
Home Sales: The National Association of Realtors reported that sales of existing homes rose 7.4% in November to the highest seasonally adjusted rate (6.54 million units) since February 2007. Meanwhile, the median sales price for existing homes rose slightly to $172,600 from $172,200 and the glut of unsold homes has been reduced to a supply of 6.5 months at the current pace. On the other hand, new home sales fell by 11.3% in November. With the median price of new homes at $217,400 or approximately 26% higher than existing homes, and 51% of all November purchases by first-time buyers, it is perhaps not surprising to see such a disparity between new and existing home sales. Since one in four mortgages is now greater than the market value of the underlying house, unemployment is still high, bank underwriting standards are particularly difficult and interest rates must eventually rise, we are less sanguine about the prospects for housing.
Industrial Production: The December ISM manufacturing index rose to 55.9 from November’s 53.6 and ahead of the consensus estimate of 54.3, while the ISM non-manufacturing index rose to 50.1 in December from 48.7 in November. Factory orders in November rose 1.1%, for the seventh increase in eight months and ahead of the expectation for an increase of just 0.5%. Durable goods orders rose 0.2% in November compared to a 0.6% decline in October. The Chicago Purchasing Managers’ Index (PMI) rose to 60.0 in December, well ahead of the consensus 55.1 and the 56.1 registered in November. Interestingly, the employment component of the Chicago PMI jumped to 51.2 from 41.9, revealing a broad surge in demand for labor and the first time in 24 months the index rose above 50. And the Philadelphia Fed business outlook index rose well ahead of expectations in December. Any way you slice it, industrial and manufacturing activity is on the mend.
Taking this data altogether, it is not surprising to see that the Conference Board’s index of leading economic indicators (LEI) rose by 0.9% in November for the eighth consecutive monthly gain. The LEI index has now overtaken its July 2007 peak and points to a strong recovery in 2010. Other indicators of strong growth ahead include the very steep yield curve and declining swap and credit spreads. While the strengthening economy suggests that the Fed may have to raise rates sooner than later, the Fed can ill afford to remove stimulus prematurely, especially in light of the squishy state of housing and stubbornly high unemployment Finally, corporate profits should be strong in 2010, with analyst expectations rising as earnings surprise to the upside. The consensus earnings estimate for the S&P 500 is now at $77.56, up from $75 at the beginning of December. We think earnings expectations for the year will continue to move higher and lead to a persistent bias to buy equities on the dip.
With all of the above in mind, here are our top ten “rose colored” possibilities, not predictions, for the coming year. Just imagine what could go right in 2010:
1. After ObamaCare narrowly becomes law, the fiscally conservative, centrist-minded “tea party” movement becomes a revolution and leads to the single-largest party turnover in the history of Congress, signaling the death of liberalism and the end of big government.
2. Neither Harry Reid nor Nancy Pelosi win reelection.
3. ObamaCare is defeated, forcing Obama to pivot to the middle. Obama negotiates a deficit-reducing restructuring of Social Security and compromises on capital gains, corporate and estate taxes. TARP and unused stimulus funds are used to reduce the deficit.
4. The Iranian people rise up to overthrow President Ahmadinejad and the Islamic Republic as we now know it, ushering in a new era of freedom and stability for Iran and the Middle East.
5. Tempted by valuation and the weak dollar, sovereign wealth funds dramatically increase investment in U.S. commercial real estate, while foreign companies go on a shopping spree for U.S. blue chips.
6. U.S. GDP averages 5% for 2010, forcing the Fed to raise interest rates. After an initial sharp correction and as interest rates move higher, the dollar strengthens and a new virtuous cycle of strong economy-higher rates-strong dollar reignites a new leg for the bull market.
7. The Fed succeeds in gradually removing liquidity from the financial system in 2010 without having to raise interest rates. GDP growth averages 3% for 2010 as the housing market regains traction. GDP accelerates as we approach 2011 and the Fed begins to raise interest rates, pulling off what will be called the “great (soft) landing”.
8. China and the U.S. agree on long-term “green” initiatives without immediately raising taxes, creating new tax incentives and abundant high paying jobs for both countries. Unemployment in the U.S. falls below 8% by year-end 2010.
9. As investors and analysts almost unanimously predict a normal 10 to 20% correction, the stock market remains surprisingly stable. Volatility is illusive and the VIX falls to a low of 10.
10. The capture of Osama bin Laden leads to the dismantling of Al Qaeda.
We look forward to working with you in the New Year and to a prosperous 2010.
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