“ The stock market is one of the best economic forecasters around. ”
The U.S. stock market’s solid gains off the bear-market low is auspicious. Bank of America research shows that 92% of the time after this happens, the market rises over the next year with an average gain of 9%. This offers no guarantee, but if I am overweight stocks as I am now, I’d rather have history on my side than not.
Moreover, it’s looking like the U.S. economy will avoid recession. Market bears keep pushing back their recession timing, but are not giving up. Their latest rallying cry is that U.S. consumers will soon run out of excess savings, slow their spending and kill growth.
This is not going to happen. Consumers have plenty of spending power. Baby boomers alone have $74.8 trillion in net worth and they are spending it, points out Ed Yardeni of Yardeni Research. Total net worth is $140.6 trillion for all U.S. households.
Next, employment remains strong, and it is not letting up. “The U.S. economy remains admirably resilient, and odds of a recession beginning this year are receding,” Moody’s Analytics economist Mark Zandi predicts. “The economy’s resilience is clearest in the job market. Job growth is steadfast at near 250,000 per month. It is difficult to envisage a recession without significant job losses.”
Beyond that, consumers have a record $7.6 trillion in annual unearned income from sources including interest, dividends, rents and Social Security. Consumer loan delinquencies are low, and debt-servicing costs are contained relative to income.
Market internals also predict no recession. Since the October lows, cyclical groups (which do better in times of growth) like tech, consumer discretionary, materials and industrials have done well. They have outperformed defensive areas like consumer non-discretionary and utilities. The stock market is one of the best economic forecasters around.
Moreover, stocks are not overvalued. While current valuations are not low, they rarely are during profits recessions. The reason is that we are several quarters into an earnings recession, and p/e ratios increase when earnings decline. The current 21 p/e on the S&P 500 SPX, +1.19% looks high, but multiples were higher during the Great Financial Crisis (28.0) and the Covid recession selloff (23.0). Over the past 50 years, the average multiple on trough earnings has been 20. Valuation is never a catalyst, but it has good predictive power. Today’s 21 multiple on the S&P 500 suggests 5.4% annual returns over the next decade based on history.
Also consider that if you take out the “Nifty 50,” or the S&P 500’s 50 biggest stocks which includes the top performers including NVDIA NVDA, +2.55%, Meta Platforms META, +3.43%, Microsoft MSFT, +2.12%, Tesla TSLA, +2.63% and Apple AAPL, +1.60%, the S&P 500 trades at a p/e of just 15. That is one standard deviation below the benchmark’s historical average multiple of 18.
Plus, inflation is receding. We’ve won the war on goods inflation, which rose just 0.6% year-over-year in May, the lowest since November 2021 and well below the 14.2% peak in March 2022. The problem is services inflation, and that remains elevated largely because of rent increases. You see this core CPI inflation, stuck at around 6% since early last year. Rent accounts for 43% of core CPI.
The impact from rents will be changing soon. Leading indicators — the most recent leases — tell us the impact of rent on inflation will be coming down. As a result, overall U.S. inflation could be down to 3%-4% by this fall, Yardeni says. Keep in mind that historically after big inflation spikes, inflation comes down about as fast as it has gone up.
Sentiment is still reasonably bearish
In investing, it usually pays to be a contrarian and bet against the crowd because groupthink is so often wrong. Investor sentiment has come up a lot since I suggested buying the U.S. market on the October 12, 2022 low for the year. But it is still bearish enough to tell us the market remains a buy.
I follow about a dozen sentiment indicators. But if you follow just one, make it the Investors Intelligence Bull/Bear ratio. It measures sentiment among stock newsletter writers. It has shot up from last October, to 2.72 from around 0.7 at the lows last year. That is a big gain, but it is still bearish enough, by how I use this measure.
For me, when this gauge hits 4.0 it means dial back on adding new positions. At 5.0 or above, it means move to cash. At 2.72, it’s still far from the warning track. This tells us we have the requisite “wall of worry” in place to own stocks. Bull markets climb a wall of worry, according to market lore. In practice this means there are enough people to turn bullish and put money into our stocks, to drive them higher.
A similarly comfortable read comes from Bank of America’s “Sell-Side Indicator.” This one tracks the sentiment of sell-side strategists at brokerages, by considering their suggest portfolio allocation to stocks. This measure was recently at 52.7%, almost as low as during the Great Financial crisis. Historically, when the indicator was at this level or lower, subsequent 12-month S&P 500 returns were positive 94% of the time. This level implies market returns of 16% over the next twelve months.
What to buy
In bull markets, companies that make money in market-related activities do well. There’s been bullish insider buying recently in Nasdaq NDAQ, +0.42% and Hennessy Advisors HNNA, ), and late last year in CME Group CME, -0.04%. Those are three to consider.
Meanwhile, cyclical stocks — which outperform during periods of predictable economic growth — have been strong. That will continue, which would favor the tech, consumer discretionary, industrials and materials sectors.
The cyclical group that really jumps out as a buy is energy. It has not participated in the market rally and the sector looks historically cheap. Energy stocks trade at an average forward p/e multiple of 9.8, vs. an historical average of 16.8. Most of us want renewables to come along as fast as possible and replace fossil fuels. But that is going to take some time. Meanwhile, economic growth will support energy demand. So, energy stocks should move higher.
Here are three in the sector that have been seeing decent insider buying. Warren Buffett continues to buy large amounts of Occidental Petroleum OXY, -0.17% stock. He’s considered an insider because he owns so much of the company. Moving down in market cap, I’ve recently suggested Comstock Resources CRK, +2.15% and Matador Resources MTDR, +0.02% in my stock letter in part because of the insider buying. Comstock is a pure natural gas play, so it will benefit as liquid natural gas facilities come on line over the next several years in the U.S.
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