PHONE: 414-223-1099 TOLL-FREE: 1-800-236-1096

Bob’s View: Midyear, Turning the Corner

Severe weather, China’s slowdown and Fed tapering contributed to a choppy beginning to 2014. But midyear, Bob Landaas cites some reasons for investor optimism. Among them: Low inflation and high profit margins. Bob spoke with Joel Dresang in a Money Talk Video. Here is a transcript of their conversation.

Joel Dresang: Bob, we’re about midway through 2014. And it doesn’t seem that long ago that we had a pretty harsh winter.

Bob Landaas: You know, and that set the stage for the first quarter of the year, Joel. Winter weather really took a toll on the economy. I’m pretty suspicious of companies that blame weather for their financial results. This time around, it really did take a toll and was the legitimate reason for the economic slowdown.

The economy is expected to grow about 2% this year, 3% next year. And we finally saw green shoots, if you will, early this spring: the improving labor markets, people were paying down household debt. We had rising stock prices, rising house prices. That improved the wealth effect.

So the economy did, in fact, turn the corner in the second quarter of this year.

Joel: We also started the year with bad news from China.

Bob: China slowed abruptly, Joel. Earlier in the year, we had a manufacturing report, in January, showed manufacturing had declined, the weakest in seven months, in China. A month later, China came out with an export number, down 18%. That’s terrible no matter how you look at it.

Emerging markets really got hurt pretty good, a third of their GDP directly tied to China. So you saw a number of things cascade after the slowdown in China, most notably, a decline in commodities prices, which curiously, pushed the inflation rates down in the United States, allowing interest rates to decline.

Joel: And what about interest rates? The bond market was pretty interesting this year.

Bob: Yes, Joel. When you look at Ben Bernanke last May, a year ago May, he talked about tapering – reducing bond buying. The bond market got hurt almost overnight. Traders have no experience on tapering. It’s never happened before, this reduction of bond buying on a monthly basis.

By the time they finally got around to tapering in December, bonds rallied.

It was widely viewed that the sell-off last May got too carried away. So what surprised a lot of investors this year is how well bonds have done at a time when everybody was expecting higher interest rates.

A lot of this is due, in fact, to lower inflation. Inflation is barely measurable. Year-over-year, the numbers are at 1.3%. We’ve averaged below 2% inflation now for a couple of years – way below the Fed target. But that’s what allowed interest rates to remain pretty low.

Joel: And what about Janet Yellen, Bernanke’s successor? She’s seeing more of these green shoots you’re talking about.

Bob: Well, you know the Fed released their minutes Wednesday. And they said a couple things.

One is that they expect to keep short-term interest rates low for the foreseeable future. They also talked about raising the Federal Funds Rate perhaps in 2016. So that’s a couple of years from now.

And they also talked about making sure that investors realize that interest rates could stay low longer than they think. And you know, I’ve contended for years, Joel, that interest rates are going to stay low because there is barely measurable inflation.

Consider that the average credit score is 620 in the United States. That’s subprime. The average American can’t qualify for a traditional fixed mortgage. Household formations continue to decline – very unusual in U.S. history. Kids are staying with their college roommates; they’re moving back home with their parents.

But if you want to know where housing’s going, there’s your answer. And with banks reluctant to lend, and the last thing they’re going to do is re-engage in subprime lending, you get an idea of why inflation is so low – because the money is not circulating.

Joel: And what does all that mean to stock investors? The stock market’s up 6% so far midyear.

Bob: You know, Joel, I’ve got to tell you, that’s above average. The average is 10% a year. So the way I do math, we’re above average now. And a lot of it came in the last six weeks – up 6% for the broader markets.

What I’m so attracted to right now is profit margins. They’re the highest they’ve ever been. And, Joel, that’s not unusual. That’s borderline rare, halfway through a business cycle for margins to stay so high.

And it’s traditional:

  • Companies have to pay more for labor. You’re no longer hiring from the unemployed; you’re taking workers from other companies, you’ve got to pay for that.
  • And, traditionally, commodities prices firm up halfway through the cycle because of demand. Because of the slowdown in China now, commodities prices have actually declined this year on average. And it drops right to the bottom line.

So margins are about 10 cents on the dollar. That’s the highest they’ve ever been. So we get to forecast that earnings are supposed to go up 11% in each of the next two years. So with a market that’s currently trading at 15.5 times this year’s earnings – that’s average – and earnings expected to go up above average for the next couple of years, I’m pretty optimistic about stock prices moving forward.

Joel: I’m hearing a lot of optimism. Are there headwinds that you’re worried about too?

Bob: Well, Joel, clearly you’ve got to focus on Iraq. When you look at the price of oil, for every $10 increase in a barrel of oil, it reduces GDP by 0.2%. That’s a lot.

Iraq is the seventh-largest oil producer in the world. So when you see instability in Iraq and oil prices go up – they went up 4% just last week – that’ll give you an idea of some of the headwinds.

And I think China would be another. China has the one thing that we don’t have, and that is control of their currency. They have the ability to stimulate domestic consumption. And as a result, most of the pros are forecasting China turning the corner, which ultimately will lead to higher prices and higher interest rates.

To read past editions of Bob’s View, please click here.

But earnings are solid, I think, for the next couple of years. Broad-based participation: Typically, markets die when investors are chasing a handful of stocks. This time around, we’ve got 10 of 10 sectors of the S&P doing well, all making money.

Volatility is low. It’s the lowest in seven years. We’ve now spent 42 days, consecutive trading days in the stock market, with movements within 1%.  You’d have to go back to 2007 to see that type of tranquility.

It won’t last forever. My guess is we’re going to have our traditional 10% sell-off at some point. That’s not the point you worry about. It’s when the fundamentals crumble. But big picture, long term, I think stocks look attractive at these levels.

Bob Landaas is president of Landaas & Company.

Joel Dresang is vice president-communications at Landaas & Company.

Money Talk Video by Peter May

(initially posted June 25, 2014)

More information and insight from Money Talk

Money Talk Videos

Follow us on Twitter.

Landaas newsletter subscribers return to the newsletter via e-mail.

Text Size:  A  A  reset

No client or potential client should assume that any information presented or made available on or through this website should be construed as personalized financial planning or investment advice. Personalized financial planning and investment advice can be rendered only after engagement of the firm for services, execution of the required documentation, and receipt of required disclosures.
Landaas & Company performs investment advisory services only in those states where it is licensed, or excluded or exempted from state investment advisor licensing requirements. All responses to inquiries made by prospective customers to this internet site will not be made absent compliance with state investment advisor and investment advisor rep licensing requirements, or applicable exemptions or exclusions from licensing.
Please contact the firm for more information.

Powered By: mindspike design
© 2024 Landaas & Company