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Bob’s View: Seeing the forest

Money Tree blowing leaves

By Bob Landaas

As the politicians in Washington keep playing high-stakes brinkmanship over federal fiscal policies, it’s important for investors to remember that the deficit is a solvable problem.

It’s not like an incurable illness for which they can’t give you a remedy or a solution or a fix. The deficit is clearly solvable. You may not like how it’s solved, but it’s solvable.

The specific issue has to do with the carrying costs of the national debt, which is still way below 1%. Because of that, the politicians don’t have to make drastic changes.

The government isn’t paying a lot to carry the debt. And until interest rates normalize – which they will eventually – but until they do, the politicians won’t have to make difficult choices. And, as a result, in my opinion, they won’t.

I think the politicians are going to keep dodging the hard choices because they don’t have to make the hard choices until interest rates go up.

Frankly, I’m relieved that I have not been asked questions lately about the deficit. I was asked about the deficit three or four times every morning and every afternoon for almost all of last year, and I’ve now gone most of this year without anybody bringing it up.

Once the dust settled over the fiscal cliff, once the elections were past us, people refocused their attention back on the fundamentals. Investors looked at the fundamentals and said, “Hmm. This looks pretty good.”

  • The stock market, measured by the S&P 500 Index, has been trading under 15 times earnings – its historical average.
  • Analysts expect earnings on the S&P to go up 9% this year – and another 11% next year.
  • Inflation has been bouncing in a very low band for the better part of four years, and it probably won’t break much higher for a while. The Fed has said it’s not going to raise interest rates until the end of 2015 – at the earliest.

When you separate out all the noise from the politicians, and you look just at corporate earnings and interest rates, the market looks compelling.

Economic indicators are fairly encouraging. Compared to a year ago, we’ve got nice gains in auto sales and housing. Trade is improving.

For the last four years, up until January, most of the new money going into mutual funds was pouring into bond funds. The flow into stock mutual funds in January was the biggest since 1996.

The S&P 500 rose 5% in January. Only once since 1950 has the market fallen in the last 11 months of the year after it rose 4% or more in January. That one fall was in 1987, which included the market crash that October.

It’s really clear if you look at sweeps of history that after a banking crisis, such as the one we had in 2008, it takes a number of years to repair balance sheets. No matter which way you pick to fix the problem, it takes a number of years for deleveraging to occur.

It’s like a forest fire. The fire goes through, destroys the old growth, and that allows the forest to rejuvenate. And then the next generation of growth is better than the previous. So going through a banking crisis and all the misery created because of bankruptcies and defaults and foreclosures, it sows the seeds for regeneration for the next cycle.

It takes a while to get started. Historically, it takes years. The forest fire is the best analogy I can come up with, but it sets the stage. So my guess is the next couple of years will be pretty good.

The Dow peaked near 14,200 in 2007 when earnings for the S&P 500 were at $88. In 2014, analysts think earnings are going to exceed $111 per share. So earnings are more than a quarter higher, and stock prices are just back to where we were in the fall of 2007. So the market still has a ways to go, based on earnings – and fundamentally that’s what drives the markets.

Bob Landaas is president of Landaas & Company.

(initially posted Feb. 27, 2013)

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