Friday, July 31, 2009

It’s a New Bull Market

Resilient capitalism pushes back against Obama.

Let’s call this what it is: A new bull market in stocks has emerged from the ashes of the financial meltdown and the deep recession that followed. And it’s signaling the onset of economic recovery. Free-market capitalism is more durable, resilient, and self-correcting than its detractors would have us believe.

This is not just a summer rally -- although a 12 percent market rise since July 10 is absolutely splendid. There’s a lot more going on here. Over the last five months, since March 9, the broad-based S&P 500 is up 46 percent. If I’m not mistaken, a 20 percent rally that is not quickly reversed constitutes a bull market. We are more than double that, and there will be no total reversal.

Consequently, I want to change the agenda. This is much grander than what most commentators are describing. This is a new bull.

With positive, beat-the-street earnings coming from all corners of the economy, the current rally is based on solid fundamentals. Roughly two-thirds of S&P companies have reported so far, and 75 percent have beaten profits expectations by about 10 percent on average. Just look at the recent results posted by companies as diverse as Dow Chemical, MasterCard, Visa, Tyco, Colgate-Palmolive, Kellogg’s, Cummins, and International Paper, all of which follow better-than-expected announcements from Caterpillar, IBM, and Intel a few weeks ago.

Incidentally, research from JPMorgan shows that sequential revenues -- second quarter over first quarter -- are rising. And investment guru Vince Farrell says there’s $11 trillion sitting on the sidelines in money-market and other short-term balances. So this rally is no empty air pocket. When markets in China plunged 7 percent earlier this week, U.S. stocks could have followed suit. But they held their own. It was a big show of bull-market strength.

And let’s not forget the banks. The KBW Bank Index has doubled since early March. With a zero short rate and a steeply upward-sloping Treasury yield curve, even a banker can make money. Financial earnings are soaring. The credit crisis is over. And the banks will earn their way out of their toxic-asset problems provided that the nerds at the Financial Accounting Standards Board (FASB) don’t resurrect mark-to-market accounting and force immediate distressed-market write-downs.

Does this bull have long legs? Historically, bull markets last an average of 17 months, and this bull should run well into next spring. And judging from the breathtaking decline in LIBOR rates, the TED spread (between LIBOR and Treasury bills), and corporate-bond spreads relative to Treasuries, I believe there’s another 20 percent upside to the bull. That would return us to the pre-Lehman levels of August 2008, with the S&P above 1,100 and the Dow at 11,000.

And here’s the economic deal: Businesses have made the necessary cost-cutting adjustments to jobs, salaries, and inventories to restore profitability. (My hunch is that businesses fired too many people when the credit roof fell in and the economic bottom fell out.) It’s a classic, Austrian, Ludwig von Mises corrective to prices and production. As the economy rises, lean-and-mean companies will reap a profitable harvest. Profits are the mother’s milk of stocks, business, and the economy. As profits heal, consumer incomes and spending will rebound.

My guess is the economy will grow by 3 percent annually or slightly more in the second half of 2009 and the first part of 2010. This growth is back-stopped by a very-easy-money Federal Reserve, which in the short-run is overcoming some of the anti-growth, war-on-capital policies hailing from Washington. It’s because of these prosperity killers that a return to the stock market peak of mid-2007 -- when the Dow climbed over 14,000 -- is not likely.

The ineffectual Keynesian spending-and-borrowing from Team Obama will actually reduce our long-run potential to grow, but at least in the shorter-term Milton Friedman’s monetary power from the Fed has re-liquefied commerce. This includes a $1 trillion rise in the Fed’s balance sheet and steady 10 percent annualized growth in the inflation-adjusted money supply this year.

Longer-term, yes -- there are inflation risks and potentially big obstacles to prosperity. A full economic recovery from a deep recession should produce 7 to 8 percent growth, as was the case with the 1983–84 Reagan rebound. But tax rates are going back up in 2011, not down. That’s the wrong side of the Laffer curve. And if we’re going to get nationalized health care, with surtaxes on the rich and higher payroll taxes for businesses and workers, then I would say: Enjoy the fat goose at Christmas this year, because there may be fewer Easter eggs next spring.

But this is much more than a summer rally. It’s a new bull market heralding a new economic recovery. Free-market capitalism is trying hard to push back against Obama’s central-planning.

The bears will lose this round.