Tuesday, June 29, 2010

Double-Dip Trade Is Probably Overdone

Stocks took a real drubbing today, with the Dow off 268 points and the major indexes basically falling 3 percent. Call it the double-dip trade.

But are we really heading for a double-dip recession? I think not. And I say this as someone who has been advising investors to take profits this year before the IRS takes them next year, as taxes on capital gains, dividends, estates, and top incomes are all scheduled to rise in 2011 — unless, of course, a tea-party Republican Congress overturns all this following the midterm elections.

Investors are worried about China and Europe in addition to a U.S. double-dip. Consumer confidence plunged this morning, but that largely may be a function of the BP oil spill, as the Gulf states reported the biggest confidence drops. And then there’s Team Obama, which shows no sign of spending restraint. Nor do they see any need to call off the tax hikes. In fact, bank taxes are going up.

Whatever the reason for today’s market drubbing, economists like John Ryding and Michael Darda do not see a double-dip. The manufacturing sector is still displaying a V-shaped recovery, while profits continue to rise across-the-board. And private-sector incomes have begun to rebound, despite the jobless recovery. This is because hours worked are being extended while hourly wages increase modestly.

Of course, the Fed remains ultra easy with a steep upward curve. And corporate balance sheets are pristine, with net corporate cash flow standing at about $1.7 trillion.

If you bet on the profits story, the price/earnings multiple on the S&P 500 stands just over 11-times earnings, which translates to an 8.8 percent earnings yield, much higher than the 6 percent corporate bond rate and the incredibly shrinking 3 percent 10-year Treasury rate.

So as a final thought, if you bet on profits and the tea-party movement, the big stock market correction is probably overdone. However, let me reiterate, unless tax policy changes, investors should sell into relief rallies in order to take profits before the Tax Man does.