Advisors on This Week’s Show

Bob Landaas

Marc Amateis

Jeff Peterson

Steve Giles

Week in Review (May 14-18, 2012)

Significant economic indicators & reports

Monday

No major releases

Tuesday

The broadest measure of inflation showed no change in April, the Bureau of Labor Statistics said. A dip in gasoline prices helped keep the Consumer Price Index from rising and led to a 2.3% annual inflation rate, the lowest in 14 months. The less volatile core index, which takes out fuel and food costs, also had a 12-month rate of 2.3%, which is below the 30-year average rate of 3.1%.

A key measure of consumer spending – retail sales – rose slightly in April after a stronger gain in March. The Commerce Department reported nine of 13 categories with greater sales in April, led by automotive. Year-to-year retail sales grew by 6.4%, the lowest rate since August 2010. The 20-year average rate is 4.5%.

Businesses added less to their inventories in March than analysts had expected, but Commerce Department figures showed stockpiles keeping pace with demand as the inventories-to-sales ratio remained near historic lows. That suggests extended caution by business executives but positions them to respond quickly to changes in demand.

Wednesday

The beleaguered housing sector had an encouraging sign with housing starts rising more than forecast in April. The annual pace of new construction increased nearly 3% from March and was up 30% from April 2011, according to a joint report from Commerce and the Department of Housing and Urban Development. While the development is positive, the pace for housing starts is only about two-thirds what it was before the recession and less than half the average since 1959.

The Federal Reserve reported better-than-expected industrial production and capacity usage in April. Boosted by a rebound in utilities after a mild winter, industrial production rose at the fastest pace in 16 months. Industries overall were operating at their highest capacity in four years. Both indicators suggest continued moderate expansion of the economy.

Thursday

The moving four-week average for initial unemployment claims declined for the second week in a row, signaling more gradual progress for the longsuffering labor market. Labor Department data showed jobless claims down 14% from the year before, the widest such gap since August. New claims below 400,000 a week suggest employers overall are adding more jobs than they’re cutting. The level has been below that number for 29 weeks in a row.

The Conference Board’s index of leading economic indicators dipped unexpectedly in April, largely from a combination of trends in unemployment claims, building permits and consumer confidence. An economist for the business research group said: “The indicators reflect an economy that’s still struggling to gain momentum. Growth is slow, but choppy, and consumers, executives and investors are looking for more progress.”

Friday

No major releases

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By Jeff Peterson

I have never been a big fan of stock market clichés, and one of my least favorites is “Sell in May and go away.”  To my knowledge, Dirty Harry never managed money professionally, but if he did, his response to such action might well be, “Do you feel lucky? Well, do ya?”

Some seasonal trends, such as the so-called January Effect, may actually have some validity because they have some basis for higher-than-normal inflows of cash to the market due to the reversal of end-of-year tax selling and pension funds making investments.

The Super Bowl Indicator, based on something as disconnected from market fundamentals as whether the team that won the Super Bowl was an original NFL (versus AFL) team, is an extreme example of what not to follow with real money. 

So what is the “Sell in May and go away” investment plan all about? Thanks to some research conducted by Zacks Investment Research in Chicago, here are the facts:

• If an investor invested $10,000 in the Dow Jones Industrial Average each May 1, beginning in 1950, and sold the position on Oct. 31 each year, the investor would have lost a total of $379. (The Dow is an index of stocks and is not available for direct investment.)
• If the same investor invested $10,000 on Nov.1 and sold on April 30 each year, the total profit would have been $609,071.

Okay, Harry, I’m feeling lucky. 

Well, not so fast.  Here are some other facts:

• Over that stretch of more than 60 years, the market was up 59% of the time from May through October.
• Five of the last seven years have been profitable over that May through October timeframe.
• In 2003, the market was up 15.6% from May through October, and in 2009 it was up 18.9%.

I believe a more reasoned approach is to recognize that seasonal influences are minor compared to market fundamentals, economic conditions, good old-fashioned investor sentiment, and the emotions of fear and greed.

The successful investor ignores myth and superstition, and I generally recommend ignoring the calendar as well. 

Oh, look! There goes a black cat. Please pass the salt.

Jeff Peterson is a senior vice president at Landaas & Company.

initially posted May 17, 2012

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Advisors on This Week’s Show

Brian Kilb

Marc Amateis

Jeff Peterson

Week in Review (May 7-11, 2012)

Significant economic indicators & reports

Monday

The Federal Reserve reported that consumer credit grew in March, and it was much greater than analysts had expected. The debt expansion continues to be concentrated in non-revolving debt such as car financing and – the biggest factor – student loans. A surge in college borrowing has come as some interest rates are about to double, pending action from Congress. Credit card debt, which is a sign of consumer confidence, rose for the first time in three months.

Tuesday

No major releases

Wednesday

March also experienced the lowest increase in wholesale inventories in four months, another indication of slowing economic momentum. According to the Commerce Department, the ratio of wholesale inventories to sales remained near historic lows, suggesting companies continue to run lean and cautious. The year-to-year build of inventories dipped to 8.4%, its lowest mark since November 2010, but that’s up from a 20-year average rate of 4.5%.

Thursday

The U.S. trade deficit widened in March as imports grew faster than exports. While analysts had expected the Bureau of Economic Analysis to show a gap narrower than the $51.8 billion reported, they also saw encouraging signs of consumerism. Americans bought more foreign-made computers, cell phones, cars, clothes and TVs. Exports also increased, allaying some fears of how a slowdown in global growth might affect U.S. companies.

Labor market conditions showed signs of revival as the moving four-week average for initial unemployment claims dipped for the first time since March and only the third time since February. Labor Department data showed jobless claims still around the levels they were four years ago. Average claims are more than 40% lower than their recessionary peak and have been below the critical level of 400,000 for more than six months.

Friday
Led by lower gasoline prices, wholesale inflation fell in April for the first time in four months. The Bureau of Labor Statistics said the year-to-year rate in the Producer Price Index dipped to 1.9%, the slightest since October 2009. Similarly, the core index, which excludes volatile food and fuel costs, nudged down to a 2.7% annual rate, the lowest since August. The data support Federal Reserve statements that inflation isn’t an imminent threat and suggest a decrease in the Consumer Price Index, which will be reported next week.

An early reading of May consumer sentiment showed the greatest optimism since before the Great Recession started at the end of 2007. The preliminary gauging by the University of Michigan and Thomson Reuters found especially strong feelings for current conditions, although consumers’ expectations for the future – which tend to affect spending plans – remained relatively weak.

Where the Markets Closed for the Week

• Nasdaq – 2,934, down 22 points or 0.7%
• Standard & Poor’s 500 – 1,353, down 16 points or 1.2%
• 10-year U.S. Treasury Note – 1.84%, down 0.04 point
• Dow Jones Industrial Average – 12,821, down 217  points or 1.7%

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By Bob Landaas                        

The two biggest reasons I hear why investors are still waiting to get into the stock market have nothing to do with stock prices. Here they are:

1. I want to wait until clarity after the election.
2. The deficit is too high in the United States. It’s going to ruin the country.

Let’s take these one at a time. No matter who gets into the White House at the end of the year, it’s positive for the markets because the markets hate uncertainty. What the markets want is clarity.

I’m positive that someone’s going to win. Generally, the majority wins. The majority of us will be going into next year feeling good about our prospects.

There’s really no correlation between the markets and the elections. There used to be. The markets tended to peak during the presidential races and then hit a low point at mid-term elections. That pattern changed in the early 1990s and has yet to repeat itself.

Equally nonsensical is the deficit. There are some people in this country convinced it’s going to bury us quickly. I’ve said this time and time again: Your canary in the coal mine is the yield on the 10-year Treasury. When that yield jumps, start to sweat.

Lately, though, the yield has been just below 2%. The historic average is closer to 6%. So when the yield on the 10-year Treasury starts to jump, that tells you that the big money around the world is no longer interested in buying our debt. That’s not the case. Money continues to pour into Treasuries. The Chinese even have upped their purchases of Treasuries over the last couple of months.

So I find it interesting that the two biggest reasons I hear for not participating in the stock market – clarity with the elections and improvement on the deficit – have very little to do, in my opinion, with where stock prices are going to go over the next couple of years. But that shows you the emotional state of many investors. As we all know, reason doesn’t have anything to do with your emotions.

It’s not that I’m dismissive of those concerns. I think that the deficit matters long-term, but short-term it doesn’t impact stock prices. Nor will the election. In spite of how emotional and how divided everyone is, there hasn’t been much of a connection between who runs the White House and how stock prices are doing over the near term.

As many of you know, interest rates and corporate earnings are what drive the stock market over the long term. Since I started in investments in 1975, corporate profits and the Dow Jones Industrial Average have expanded by almost exactly the same rate.

Bob Landaas is president of Landaas & Company.

initially posted April 26, 2012

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By Brian D. Kilb

As lifespans increase, many people have the blessing of parents and grandparents as an ever greater part of their lives. With that longer life expectancy come greater challenges – and opportunities, including chances to pay back your parents for the guidance and support they offered you through the years. Here are some suggestions.  

To help your parents, you need to understand their situation. Inquire about their financial circumstances. Make sure they have adequately planned for their estate. By sharing those details, they open the door for you to be of service. Determining their financial stability can help lay the groundwork for many decisions down the road. Seeking professional advice can help. Often clients bring their parents in to meet with me to get the ball rolling.  

Perhaps the most avoided decision aging parents face is deciding when to move out of the house. Help them by promoting a civil discussion about when and where they should move. Many big decisions like this are “event-driven” – with outside circumstances, such as a dramatic decline in health, forcing change. Like all matters relating to planning, you want to be in control. You will have far greater success, as defined by your parents’ happiness, if you take the time to think ahead. Determine what criteria should trigger a move, and research your options.   

No decision is more difficult than being forced to determine whether life-sustaining care should be continued for a loved one. Medical power of attorney is a legal document designed to define and authorize what care is to be sustained when health is permanently compromised. Talk with your parents about what choices should be made on their behalf. When everyone agrees, make sure the instructions are formalized legally and understood. You may be called on someday to provide support or be the decision maker for end-of-care decisions. Making that gut-wrenching call will be much easier if you know your parents’ wishes in advance.

Look out for your parents. Visit often and watch for signs of deterioration. If you pay attention, you can pick up on clues that their situation might be getting worse. Check to see that they’re taking required medicines. Have they lost weight or seemed unusually slower? A little help with the house now could save repair costs or lost value later. The expression “an ounce of prevention is worth a pound of cure” is apt.

Saying “No” to your parents is no easier than saying it to your kids. But it can be just as necessary. It’s hard for aging parents to give up their freedoms. Driving is one example. When driving skills have diminished appreciably, it brings danger not only to your parents but to others. Work with your mom or dad to share the burden of making and communicating such decisions. Put yourself in their position. Try reasoning with them. But be firm.

As a financial advisor, I’m in the middle of many family conversations over who will take responsibility for the needs of aging parents. Rarely do I see the process unfold without one sibling feeling a far greater workload. Discuss upfront how to share in the tasks equally. Whether you are nearby or 1,000 miles apart, there are plenty of ways to help. A thoughtful conversation at the first signs of trouble will save countless hours of anxiety as things get worse.

Guiding your own children as they grow and face challenges can at times be a daunting responsibility. Offering your parents guidance and support as they face the challenges of aging can also be a load to bear. You have a chance to pay them back for being good parents by being part of their lives as you work together to help them age with grace and dignity. 

Brian Kilb is executive vice president and chief operating officer of Landaas & Company.

initially posted May 9, 2012

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Advisors on This Week’s Show

Bob Landaas

Brian Kilb

Paul Coldagelli

Week in Review (April 30-May 4, 2012)

Significant economic indicators & reports

Monday

The driver of 70% of U.S. economic activity, consumer spending rose a little less than expected in March but followed a strong February and remained at a reasonable pace. The Bureau of Economic Analysis said personal income rose more than analysts had forecast. The same report showed a key inflation measure – the core Personal Consumption Expenditure index, rising at a 2% annual rate for the fourth month in a row. That’s about where monetary policy officials at the Federal Reserve have said they’d like inflation to be at this point.

Tuesday

Manufacturing appeared to pep up in April after slowing its advance in recent months, according to the Institute for Supply Management. The trade group’s index, based on surveys of purchasing managers, hit its highest level in 10 months, much better than experts had expected.

Also beating expectations, motor vehicle sales rose slightly in April, at an annual rate of 14.4 million vehicles. Figures from Autodata Corp. show that next to February, vehicles sales climbed to their highest point in four years.

Wednesday

Echoing some other reports suggesting a recent slowdown in manufacturing demand, the Commerce Department said factory orders declined in March for the second time in three months. The monthly report is considered a volatile economic indicator but showed broad declines beyond a drop in commercial airline orders. The ISM Manufacturing Index for April offers hope, however, that orders since have improved.

Thursday

Labor market conditions are still sorting out, according to the moving four-week average for initial unemployment claims, which rose for the fourth week in a row. Labor Department data showed jobless claims at their highest level since December while still 42% lower than the bleakest point of the recession. Claims have been below the critical level of 400,000 for 27 weeks in a row.

The ISM non-manufacturing index disappointed analysts by dropping more than expected in March, the second decline in as many months. But it still suggested continued expansion for the 28^th month in a row with none of the categories in the index showing contraction.

Productivity fell in the first quarter as labor output dipped even as hours increased, according to the Bureau of Labor Statistics. Economists said lower productivity could signal that employers can’t squeeze any more work out of their staff and need to hire more. The same report showed labor costs dropping, meaning inflation still isn’t much of a near-term concern.

Friday

The April employment report showed fewer jobs created than expected with barely a budge in hours worked or wages earned. Employers added 115,000 jobs in April, less than half the three-month average, raising questions about the sustainability of America’s modest pace of economic growth. The unemployment rate dipped to 8.1%, the lowest since January 2009, but much of that reflected Americans dropping out of the job market. Positive signs included statistical revisions showing 53,000 more jobs than previously estimated in February and March, as well as a rebound in temporary hires, which tends to portend increases in permanent positions.

Where the Markets Closed for the Week

• Nasdaq – 2,956, down 113 points or 3.7%
• Standard & Poor’s 500 – 1,369, down 35 points or 2.5%
• 10-year U.S. Treasury Note – 1.88%, down 0.06 point
• Dow Jones Industrial Average – 13,038, down 196 points or 1.5%

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To foster financial literacy, we regularly feature discussions on common terms and concepts used in personal finance and investing. Here’s an article from Kyle Tetting on Exchange Traded Funds, or ETFs.  

An investment instrument devised originally for professional money managers is becoming more popular among individuals, with the lure of low costs and flexibility. But there may be more to ETFs than meets the eye.

An Exchange Traded Fund – or ETF – is a basket of securities, much like a mutual fund except it trades and is priced throughout the day, instead of once a day.

Investment companies created ETFs initially to track an index such as the Standard & Poor’s 500 large-company stocks, but the concept has evolved over time.

In January 1993, the Securities and Exchange Commission approved the sale of the first true ETF in the U.S. That fund, the SPDR (Standard & Poor’s Depositary Receipts), or Spider fund, tracks the S&P 500 and is currently the largest ETF on the market. (The S&P is an index of stocks and is not available for direct investment.)

SPDR paved the way for ETFs to track everything from foreign markets to individual market sectors, with ETFs for everything from natural resources, precious metals and energy to consumer goods, banks and real estate.

The first ETFs were marketed to institutional investors for use in sophisticated hedging and investment strategies. But as interest grew, so has the scope of ETFs.

Growth of ETFs

Since the initial offerings, the ETF market has grown at a staggering pace with hundreds of new funds added every year. Additionally, the investment community has started to embrace ETFs for their many perceived advantages, spurring even more growth. 

What started as an approach to index investing has evolved into a complex counterculture of investments. ETFs are now available in broad categories such as currency, bonds, materials and commodities.

Even more recently, we have seen the creation of actively managed ETFs. We have also seen a new breed of ETFs that utilize leverage to produce sometimes twice or three-times the daily returns of a particular index or sector as a tool for frequent traders to place daily bets. 

However, the SEC and Financial Industry Regulatory Authority have urged caution in using leveraged ETF products as a long-term holding. Those products are designed to replicate daily returns and over longer periods will not keep up as a result of the effect that the arithmetic of leveraging has on them.

With ETFs’ publicized growth and support from a number of advocates who promote all the positives, an alternative product once left for institutional investors has become increasingly popular with individual investors and advisors. 

Individual investors once relegated to managed mutual funds of stocks and bonds have been lured to ETFs by low costs and variety. And with the influx of new and innovative investment ideas, the ETF market has been well-positioned to adapt to changing investor demand.

ETFs can offer greater trading flexibility and transparency than mutual funds. Because ETFs can be traded throughout the day, they publish their holdings daily, unlike mutual funds whose disclosures vary, but as a whole publish much less frequently.

Also, since ETFs tend to stick to indexes, meaning few trades within an ETF, they are often considered to be more tax-friendly than actively managed mutual funds. Since the indexes don’t change much, index ETFs have little turnover, which equates to fewer taxable events for investors.

ETFs appear to be a lower-cost solution to mutual funds or a diverse basket of individual stocks and bonds. This is because ETFs generally carry lower expense ratios than a mutual fund but can still be purchased in a single transaction, unlike an investor who looks to diversify by purchasing a basket of individual stocks and bonds.

However, after taking into account commissions and the cost of advice for novice investors, the cost of ETF investing is not necessarily less than mutual funds.

Unlike many mutual funds, ETFs themselves do not pay advisors, so individuals looking to invest are often charged hefty commissions, which may encourage unscrupulous advisors to make frequent changes, buying and selling for the sole purpose of charging their clients commissions on each transaction.

One other common approach is to charge an advisory fee on top of the funds’ expenses, further adding to the cost.

What about risk?

Many proponents argue for ETFs – specifically ETFs tied to indexes – by saying that it is difficult if not impossible for any mutual fund manager to consistently beat the market.  Therefore, they reason, given the lower expenses of an index ETF, an investor should be better off with index-like returns from the ETF over time.

While every mutual fund may not consistently track index returns, the real issue is not potential returns but risk.

Index ETFs can promise an index return, but with it comes index risk. If the S&P 500 goes up or down 10%, you can expect an S&P 500 index fund to move in sync.

However, many mutual fund managers are more concerned with the risk side of the equation, with many funds choosing to take on much less risk than the market while still realizing good returns on a risk-adjusted basis. 

Given the active management and ability to make changes based on forward-looking ideas, the right portfolio of actively managed mutual funds should be better able to control the risk side of the equation.

ETFs can be a great tool for investors looking for specific exposure to a wide range of investments. They also allow for complex trading strategies that institutional investors have relied on for years.

While ETFs have their place for many investors, the active management and long-term track record of many of the mutual fund industry’s top funds continue to provide excellent opportunities to manage risk. 

Kyle Tetting is a registered representative and associate at Landaas & Company.

posted May 4, 2012

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By Sam Beres                           

London – My semester of study in London made me realize that the United Kingdom has taken a backseat to the U.S. and the euro zone. The focus is rightly on the U.S. and the 17-country region using the euro as a common currency. They have greater impact on the global financial markets. But there are lessons to be learned from the current U.K. situation.

Based on the data, the U.S. has proved more proficient at handling the global financial crisis and the ensuing recession. The U.S. addressed the downturn with fiscal and monetary policies that dampened the crisis and kept the recession somewhat in check.

The U.S. gross domestic product continues to show slow, yet sustainable growth while a recent U.K. GDP report announced a double-dip recession for the first time since 1975. Two main reasons for the U.K.’s double dip:

1. increased uncertainty in the euro zone
2. lack of personal consumption expenditures combined with heavy government austerity.

Euro zone Woes

Euro zone GDP contracted by 0.3% in the first quarter and consumer confidence slumped. Unemployment reached 10.9% in March – the 11^th consecutive monthly increase and the highest since the 1999 introduction of the single currency.

The U.S. is one of the heaviest investors in Europe, so the crisis is definitely disconcerting, but take a moment to think of the implications a declining euro zone has for the U.K. Geographical proximity makes the euro zone a main customer for U.K. goods and services.

The zone’s large impact on the U.K. economy means that nearly every front-page headline of every morning and afternoon newspaper I see is about the euro zone. Facing public pressure, the Bank of England is expected to make a decision about an additional round of quantitative easing, fanning fears of prices going even higher than the current 3.5% inflation rate, which is well above the Bank of England target of 2%. This only goes to show the important timing of the Federal Reserve’s first two rounds of quantitative easing for the U.S. recovery.

Personal Consumption, Government Austerity

Consumer spending generally leads GDP growth in a healthy economy. Governments often pick up the slack when consumer spending decreases in tough times. We saw that in the U.S. during the financial crisis. And though the U.K. and other countries were no different at the time, the situation has changed.

U.S. consumers are now leading the expansion of the GDP, while personal consumption in the U.K. continues to lag and lack stability. At the same time, the U.K. government is implementing large austerity measures aimed at controlling the deficit. On the one hand, headlines reflect public worry over the euro zone, but I also see citizens protesting in Trafalgar Square over the government’s fiscal irresponsibility.

In the end, what does the U.K. public desire more – a growing economy or decreased government budget? They may not both be possible in the current situation.

As for the U.S., I want to see the budget deficit cut and under control. As a young American entering the workforce next year, I and my generation will likely shoulder a large part of the deficit-cutting process through reduced programs and higher taxes.

There is a point, though, where fiscal conservatism can impact the drive for renewed growth. The U.S. is in a much better place than the U.K. economically, but at what point could austerity in the U.S. impact our slowly growing economy?

Why Should U.S. Investors Care?

I am not going to make any bold predictions about whether a stubborn euro zone will have a larger drag on U.S. markets or whether U.S. deficit cuts will put pressure on GDP growth. As Bob Landaas always says, corporate earnings and interest rates drive the market, and right now they show no reason to worry.  

I suggest that U.S. investors keep a keen eye on the situation in the U.K. The U.S. was the world’s guinea pig as countries attempted to recover after the financial crisis. Now the U.K. is the guinea pig, as it experiences greater effects from the euro zone and attempts more drastic measures to balance the budget.

The situations between the two countries may not perfectly align, but the U.S. has something to learn from the outcomes of U.K. policies as the euro zone crisis carries on and the U.S. deals with its own deficit in the near future.

Sam Beres is a former intern at Landaas & Company and a finance major at the University of Notre Dame, where he plans to graduate in 2013.

initially posted May 4, 2012

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Advisors on This Week’s Show

Bob Landaas

Brian Kilb

Marc Amateis

(with Max Hoelzl and Joel Dresang)

Week in Review (April 23-27, 2012)

Significant economic indicators & reports

Monday

No significant releases

Tuesday

With perhaps nowhere left to go but up, home prices narrowed their year-to-year losses in February but remained below year-earlier figures for the 17^th month in a row, according to the 20-city S&P/Case-Shiller Home Price Index. Of the 20 cities, 15 had slighter 12-month losses than in January. The overall index narrowed for the second month in a row.

Another measure of the beleaguered housing industry, new-home sales, dipped 7% in March, which was stronger than analysts had expected. Revised data from the Commerce Department and the Department of Housing and Urban Development showed February sales to be the highest since the homebuyer tax credit stimulus in 2010. Even so, the annual sales rate is about half the average rate since 1963.

Consumer confidence edged down slightly in April for the second month in a row. While opinions continued to warm to current conditions, the outlook took a setback, the Conference Board reported. Only 14% of those surveyed expected income gains in the next six months, down from 15.5% in March.

Wednesday

Year-to-year gains in orders for durable goods stayed above average in March, but the monthly figures declined for the second time in three months. Orders slowed broadly across industries, led by the volatile commercial aircraft category, according to the Commerce Department. Orders for nondefense capital goods excluding aircraft (an indicator of business investment) fell slightly from February, when orders had been more robust than previously reported.

Thursday

As a reminder that labor market conditions are still sorting out, the moving four-week average for initial unemployment claims rose for the third week in a row. Labor Department data showed jobless claims 42% lower than the height of the recession and below the critical level of 400,000 claims for the 26^th week in a row.

The National Association of Realtors said its pending home sales index gained 4.1% in March, up from a stronger February than previously reported. The housing market has clearly turned the corner,” an economist for the trade association said. Inventory has fallen with rising sales, which should help stabilize prices.

Friday

The economy grew at an annual rate of 2.2%, slower than expected in the first quarter, according to the first of three estimates from the Bureau of Economic Analysis. By comparison, the Gross Domestic Product advanced 3% in the fourth quarter, which was the only higher rate in 2011. Better-than-expected consumer spending led the first-quarter growth with assistance from auto manufacturing and homebuilding. Government spending continued to decline. A key measure of inflation remained within the comfort zone set by the Federal Reserve, which is watching for the point at which low interest rates spark higher prices.

April consumer sentiment advanced slightly from March as Americans continued be feel lackluster toward current conditions but grudgingly more optimistic about future prospects. The report from the University of Michigan and Thomson Reuters news service suggested that much of consumers’ outlook is based on the anticipation of more jobs and lower gas prices.

Where the Markets Closed for the Week

Nasdaq – 3,069  up 68 points or 2.3%

Standard & Poor’s 500 – 1,404, up 25 points or 1.8%

10-year U.S. Treasury Note – 1.94%, down 0.03 point

Dow Jones Industrial Average – 13,234, up 204 points or 1.6%

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This is the point where we should explain what’s been driving earnings up until now and what’s probably going to be driving them in the future – and what’s going to propel stock prices higher.

When you look at the earnings gains since the financial crisis in 2008, much of it has come because of an increase in profit margins. Companies have been relentlessly reducing costs – laying people off, trying to skinny the manufacturing process, trying to do everything they can to reduce their costs. And they were very successful at that. That largely resulted in the expansion of earnings up until now.

It’s nearly everyone’s judgment that margin expansion is behind us.

So the only other way you can improve earnings is through revenue growth. Top line revenue growth for the 500 biggest companies in this country can’t be a whole lot larger than GDP growth. So we’re talking about somewhere in the range of 3% to 4%.

But there’s one other option for increasing stock prices without increasing earnings.

I’m reading more and more about the potential for an expansion of the price-to-earnings multiples. Stocks are trading, give-or-take, for about 13 times their expected earnings per share for 2012. Historically, they trade at more than 16 times earnings.

So it’s possible to see a 15%-25% increase in stock prices – not with earnings going up that much but because of an expansion of the multiples. As people become more confident in the stock market, as retail sales continue to be fairly good, as consumer confidence continues to hit higher plateaus, that dovetails into the very real possibility of an expansion of the multiples – an increase in the P/E s. So if the P/Es go from 13 to 16, you just saw a 23% increase in stock prices (3÷13=0.23) without earnings going up a nickel.

We know just through the laws of physics that the time you spend below mean argues for either heading toward mean or even spending time above mean. We’re looking at multiples around 16 as the mean.

A number of years ago, Abby Joseph Cohen, at the time the chief economist for Goldman Sachs, wrote extensively about how the market could support higher P/Es in a low-inflationary environment. Folks, this is a low-inflationary environment.

As a result, my money is on the very real possibility that over the next couple of years we’re going to see not only revenue growth that will help earnings, but the distinct possibility that we’re going to see an expansion of the multiples.

I think that’s going to surprise a lot of people as we get more and more confident, as we get further and further away from the financial crisis, as we continue to create give-or-take 200,000 jobs a month on average and as retail sales hang in there.

You add all that up, and I think you’re looking for a pretty good ride in equities for the next couple of years.

Bob Landaas is president of Landaas & Company.

initially posted April 25, 2012

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