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Bob’s View: Market Efficiency

By Bob Landaas                         

Interest rates and corporate earnings drive stock prices, and I marvel at how efficient the financial markets are – in spite of all the day-to-day noise.

Earnings are supposed to go up 13% this year. And a little more than halfway through the year, stocks were up a little over 6%. That’s the way it should work.

In a normal year, if earnings go up 13% – as long as interest rates don’t take off on us – stock prices should go up 13%. And interest rates have been flat as a pancake all year. If anything, they’re trending lower. Earnings are supposed to go up 13% this year, and halfway there, stocks were up a little over 6%.

It’s been a circuitous route. We were doing pretty well until February, when the riots broke out in Egypt. Then the earthquake and tsunami hit Japan on March 11. Supply chain disruptions were way more than expected, and that spiked oil up to over $100 a barrel, creating quite a bit of weakness in the springtime. By the summer, though, the supply chain disruptions started to subside, oil dropped below $100 a barrel, and folks started to pay more attention to earnings.

It’s all about earnings.

Earnings per share of the 500 stocks in the Standard & Poor’s index, excluding negatives, hit a record $94 back in October of 2007. The pros think sometime this summer, we’re going to pass $94. So what I’m telling you is that the 500 biggest companies in America are going to hit record levels of profit this summer.

The reason a lot of people do a disconnect when we talk like this is that they look at the unemployment rate – so many people out of work, 23 million Americans either unemployed or underemployed. Everybody knows somebody in financial trouble. Everybody knows somebody struggling with a job situation or trying to sell a house.

The reason why people don’t get their arms around the fact that the 500 biggest companies in America are going to hit record profits this year is because they’re U.S.-centric in their view. If they are, they don’t get what’s going on. Companies that have a toehold overseas are doing pretty well.

If you look at Brazil, China and India – we’re talking about 40% of the planet – their economies are growing in excess of 7% a year now. Forty percent of the world! They have the wind to their back, didn’t have financial crises, didn’t have banking crises, have younger populations, have governments with surpluses – not deficits. They don’t have the structural headwinds that the West has.

And as a result, I’m fairly upbeat for the rest of the year. I think we’re going to finish the year up 10% or more in stock prices. I think earnings are going to come in close to 13%, and people are going to look at the debt ceiling noise as just a bunch of ancient history.

You think about three years ago, people were worrying about whether the lights were going to get shut out or not. Two years ago, people were worrying about whether we would ever get a recovery. Last year, they were worried about whether we were going to double dip or not.

Now I get to tell you we’re not a recovering economy anymore. We’re clearly in the expansion phase of the business cycle. And it’s my favorite phase of the business cycle: The time between transitioning from recovery to expansion yet before the point at which the Fed starts raising rates.

So, as chaotic as things are out there, enjoy this sweet spot for the next year or so. I think stocks are going to do pretty well. Now, it’s not without obstacles, it’s not without setbacks. But in the period between now and the point at which the Fed starts raising rates, stocks tend to do pretty well, so does the economy.

You’ve got plenty to worry about, but what I’m trying to tell everybody is enjoy this period.

Bob Landaas is president of Landaas & Company.

initially posted July 26, 2011

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