Stock Market Got You Nervous? S&P 500 Says Smooth Sailing

By Michael Lombardi, MBA

Yes, I know all the news today is about the audacity of a Greece Referendum on getting free money (I talk about that in “Michael’s Personal Notes” below), but there are two stock market-related important news items I want to share with my readers first.
The third quarter ended September 30, 2011, marks the 11th straight quarter that the corporate earnings of the S&P 500 have beat analyst expectations.
Abby Cohen, senior U.S. investment strategist at Goldman Sachs Group Inc. (NYSE/GS) said yesterday that the S&P 500 is trading at a 33% discount to past periods of similar inflation. I’m not one to put much faith in the forecasts or statements of other analysts, but we need to put into context what Cohen is saying relative to corporate earnings at the S&P 500.
The S&P 500 is trading at 14.9 times current corporate earnings; not cheap, but not expensive either. However, the S&P 500 is trading at only 12 times estimated earnings for the 12 months ahead. With the S&P 500 beating analyst’s corporate earnings expectation 100% of the time over the past 11 quarters, achieving estimated earnings in the current quarter and the next three quarters of 2012 is not a stretch.
Dear reader; this is what I’m saying to you about stocks, as we enter the final two trading months of 2011:
The S&P 500 is priced at 12 times future earnings, an historic bargain. The dividend yield for the S&P 500 is presently 2.2%, better than what you can get on a 10-year U.S. Treasury (I’d rather own the S&P 500 than a 10-year U.S. Treasury for the next 10 years).
No, stocks are not a screaming bargain. But when you look at the interest rate environment today, when you look at the alternative investments to the S&P 500 and the Dow Jones Industrial Average, you realize that stocks are not a bad place to be, especially when the S&P 500 continues to surprise analysts and investors with corporate earnings that consistently beat estimates.
Please, don’t let the daily gyrations of the stock market influence you. Historically, stocks are undervalued compared to their corporate earnings and the present interest rate environment. Bullishness does not prevail amongst stock advisors and investors; in fact, bearishness does (see Forget the Economy: These Companies Are Still Earning Big Money).
These big daily losses and gains for the S&P 500 and the Dow Jones Industrial Average are a way for active traders to make a lot of money. While I realize it’s nerve-wracking to see the value of your investment portfolio fluctuate so much on a daily basis; but remember the more the daily markets fluctuate, the more money the day traders make. Traders want markets that move one percent to two percent a day!
For investors like you and me, there is very little evidence that the bear market rally that started in March of 2009 is over (see Strong Corporate Earnings and the Bear Market: How it Will Play Out).
Michael’s Personal Notes:
All the financial news this morning and yesterday was focused on the Greek Prime Minister’s idea for Greece to have a referendum on the Europe Union’s financial rescue package.
It’s a good thing.
The euro, my dear reader, is in jeopardy. When I travel to Europe each year (twice so far in 2011), I can’t understand how 17 countries, all with different goals and aspirations, can share the same fiat currency. It’s quite unbelievable how economically rich and poor countries share the same money.
Italy’s primary goal these days is to increase tourism. Germany’s goal, from what I can see, is to become the leading economic growth engine of Europe, with the headquarters of all the major European manufacturers (think cars) located in Germany.
The obvious is the obvious. Under the pressure of German Chancellor Angela Merkel and French President Nicolas Sarkozy, European banks agreed to take a 50% haircut off the value of their loans to Greece. Merkel and Sarkozy spearheaded an unprecedented European Union bailout of Greece.
And what does the Greek Prime Minister do? He throws a big wrench in the plans: he wants his people to vote on it! He wants his people to vote on getting free money!
While frowned upon by equity analysts and the media, a Greek referendum is sheer genius.
Here’s what a Greek referendum on the proposed European Union’s bailout of Greece does: it signals that democracy is important in Greece, it solidifies the Greek Prime Minister’s popularity (Andreas Papandreou’s popularity among voters plunged after he introduced so many austerity measures), and it confirms that Greece wants to be part of the euro currency. And that is what it’s all about…making sure the euro survives.
Greece has a sweetheart of a deal: Greece will receive about $180 billion and enjoy a 50% write-down in the value of its debt. It literally is free money. The Greek voters are not stupid. They know the severe repercussions if Greece doesn’t accept the European Union-led bailout. What this vote really does is strengthen the euro, something that will make the Chinese “lenders of last resort” very happy.

Where the Market Stands; Where it’s Headed:

Nice way to start a month…
The Dow Jones Industrial Average plunged 297 points in its first trading day of November. For the record, the Dow Jones Industrials gained 12.5% in October…one of its best months on record. In October, the stock market rebounded from the severely oversold level I had been writing about the past few weeks.
No, the bear market rally in stocks that began on March 9, 2009, is not over. The stock market doesn’t roll over and collapse when stock advisors are bearish and when investors are so worried about the economy and the stock market.
We are still in a Phase II bear market. During this phase, the stock market moves higher during a rally that can last three to four years. The purpose of the rally is to bring stock market investors back into stocks with the false sense that the economy is recovering.

What He Said:

I’ve been pushing gold bullion and gold shares for over a year now. Bank in January 2002, I personally started buying gold shares.” Michael Lombardi in PROFIT CONFIDENTIAL, December 13, 2002. Gold bullion was trading under $300.00 an ounce when Michael first started recommending gold-related investments. Many gold stocks recommended in Michael’s advisories have experienced spectacular gains.
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Why We Can’t Have a Sustained Economic Recovery

By Michael Lombardi, MBA

Things are looking up for the economy again. Unfortunately, things are not always as they seem.

The U.S. Commerce Department said that the U.S. economy grew at 2.5% in the third quarter—the fastest pace in a year. Moody’s Investor Services last week raised the corporate ratings of both Ford Motor Company (NYSE/F) and General Motors Company (NYSE/GM), an indication that the car companies are doing better as well. All of a sudden, people are feeling good about the U.S. economy again.

But it was only this summer that analysts were calling for a second U.S. recession. Some economists said we were already in a recession. The numbers being released on the economy beg to differ. Or do they?

Fickle…that’s the word I use to describe today’s modern economists. The stock market starts heading down (as it did this past August) and all of a sudden we are headed for a recession. The stock market gets close to new high (as we are now), and the economists say we’ve turned the corner and are out of the recession.

What’s the truth? How do we make sense of all these numbers to make the right decision for our investment portfolios and for our businesses?

I’ll get right to the point, my dear reader. We cannot have a sustained economic recovery without a recovery in the real estate market (see Without This Fixed, the Economy Cannot Recover). Job growth in the U.S. will not happen unless the construction industry, housing industry and real estate market in general come back. And, from all sides, we can see that the housing market is far from a recovery.

Consider these facts about the real estate market:

The median price of a new U.S. home fell 10% in September 2011 from September 2010, the biggest drop in two years.

The median price of a resale home, which makes up 94% of the real estate market, fell 3.5% in September 2011 from September 2010.

Cash deals account for 30% of all home resale transactions in the U.S.

The Dow Jones U.S. Home Construction Index, an index comprised of the largest U.S. homebuilder stocks and a great leading indicator of the real estate market, is still down 80% from its 2007 high—the worst performance of all Dow Jones sub-indices

Now here’s the scary part about the real estate market: According to Bloomberg, there are 11 million homes in the U.S. where the mortgages are higher than the value of the homes.

Until we have a recovery in the real estate market, which could be years off, we can’t have a bankable economic recovery. That’s the bottom line. And that’s why we simply continue to be in a bear market rally—a period in which the stock market moves higher as the bear completes its Phase II cycle of luring investors back into the stock market before stock prices fall again.

New Cycle of Rising Interest Rates Closer Than We Think

If there is one thing that keeps me up at night, it is this simple question:

What will happen to the U.S. economy when interest rates start to rise?

The U.S. economy is ever so sensitive, likely the most sensitive it has been since World War II. The Federal Reserve has done an excellent job at keeping us away from a second Great Depression. The Fed has kept short-term interest rates near zero for years. The Fed has bought U.S. Treasuries (an unheard of action) and is trying to keep long-term interest rates down by buying long-term securities.

But we must face the facts: after a 25- to 30-year down cycle in interest rates, the unprecedented expansion of the U.S. money supply will create inflation. This is what the 10-year bull market in gold bullion has all been about. And, as inflation sets in, interest rates will rise (see The Economy? Stocks? This Is a Bigger Risk).

And herein lies the biggest problem with the economy.

The U.S. real estate market is already in trouble (read my lead story for today). If interest rates start to rise, the proverbial final “nail in the coffin” will have been delivered to the already-hurting real estate market.

My historical studies show that interest rates move in 20- to 30-year cycles, either up or down. Given the record increase in the money supply and record increase in the national debt, rising inflation will be the catalyst that leads to higher interest rates.

There is no doubt in my mind that interest rates will start a new 20- to 30-year up-cycle. It is only a matter of when it starts…and it might be earlier than most of today’s economists think.

Where the Market Stands; Where it’s Headed:

Last trading day of the month and it looks like October is going to go out with a bang! What a difference a month makes. We started out October close to 10,400 on the Dow Jones Industrial Average. We are closing the month around the 12,000 level. But, despite the market recent run-up, pessimism still reigns with stock advisors, investors, and consumers.

We are in Phase II of a secular bear market. This phase of the bear market will move stock prices higher, as the bear convinces investors that stocks are a safe investment again. Phase II of bear market rallies can last three to four years. This bear market rally has lasted 32 months thus far and shows no signs of abating.

What He Said:

“A Stock Market’s Obituary: It is with great sadness that we announce the passing of the Dow Jones Industrial Average. After a strong and courageous battle, the Dow Jones fell victim to a credit crisis and finally succumbed on Friday, October 3, 2008, when it fell decisively below the mid-point between its 2002 low and its 2007 high.” Michael Lombardi in PROFIT CONFIDENTIAL, October 6, 2008. From October 6, 2008 to November 27, 2008, the Dow Jones Industrial Average experienced one of its biggest two-month losses in history.
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