Despite the wintry Arctic chill, the economic recovery is in full bloom. Or is it? Wages are stagnant, unemployment remains stubbornly high at seven percent, and consumer confidence remains tepid at best. The average American investor clearly isn’t enjoying the Wall Street perpetual momentum machine.
Are stocks fairly valued (i.e. cheap), and is the current momentum sustainable? If you consider the charts, it looks like well-heeled investors think the market is inexpensive; how else can you explain the current bull market marathon? This is after an increasingly larger number of companies on the S&P 500 warned about revenues and earnings.
In the third quarter, a record 83% of all S&P 500 companies revised their third-quarter earnings guidance lower. So far, 92 of the S&P 500 companies, or 89%, have already issued negative earnings guidance for the fourth quarter. In spite of the warnings, the markets continue to tread higher.
I’m not the first person to say you can’t beat the Fed; but this market proves it every day. Thanks to the Federal Reserve’s $85.0-billion-per-month easy money policy, the markets just go higher and higher.
So, are the markets fairly valued? Not if you think S&P 500 revenues and earnings are important. Over the last few years, companies have been doing a good job at cutting costs; in fact, corporate profits are at an all-time record high at 70% of GDP. (Source: “Corporate Profits Are At An All-Time Record Peak At 70% Of GDP,” Forbes web site, November 30, 2013.)
S&P 500 earnings are also being artificially inflated due to low corporate tax rates. While the top corporate tax rate is 35%, few companies pay that once deductions, credits, and loopholes are factored in. Thanks to a growing deficit, Washington will be looking for ways to generate cash, meaning the tax rate will most likely climb higher, which also means corporate profits will dip. (Source: “Corporate Taxpayers & Corporate Tax Dodgers 2008-2010,” Citizen for Tax Justice web site, November 2011.)
The near-record-low interest rate environment is also helping S&P 500 companies report deceptively solid numbers. According to one report, the low-interest-rate environment has helped boost corporate profits in the U.S. and U.K. by five percent in 2012 alone. At the same time, households in the U.S. and U.K. lost a combined $630 billion in net interest income. (Source: “QE and ultra-low interest rates: Distributional effects and risks,” McKinsey & Company web site, November 2013.)
Low interest rates mean companies can issue low-cost debt and use the proceeds to repurchase shares. By reducing the share count, organizations can inflate their earnings. More than 80%of the S&P 500 companies are currently employing this strategy, and at the fastest pace since the 1990s. (Source: Perlberg, S., “GOLDMAN: Here Are The 23 Best Stocks For Fat Dividends And Huge Buybacks,” Business Insider web site, October 10, 2013.)
As long as interest rates are artificially low, companies will continue to borrow and buy, especially when you consider that more than 40% of the yearly gain in earnings-per-share (EPS) growth by S&P 500 companies has come from share repurchase programs. (Source: Condon, B., “Narcissist's rally led by giant stock buybacks,” USA Today web site, May 18, 2013.)
With stocks going up irrationally, now might be the time to consider those precious metals that have been unfairly punished in step. When it comes to standing on its own, I trust gold and silver more than I do financially engineered stocks.
This article Three Indicators to Turn Your Trust Back to Precious Metals by John Paul Whitefoot, BA was originally published at Daily gains Letter.