Bulls continue to climb their wall of worry, as uncertainty from the latest “bricks in the wall†created by Russia in Crimea, slowing growth in China, and Fed tapering fades into the mosaic. Thus, stocks continued their relentless climb last week, hitting yet another new intraday high — but notably not a new closing high — while global IPO volumes for 2014 hit $38 billion year-to-date (which is about double last year’s level), and the Federal Reserve’s balance sheet expanded to a new all-time high. Cautious optimism among investors is the prevailing sentiment, as opposed to the levels of extremes proclaimed by growing chorus of negativity. In fact, it seems that the doomsayers are helping keep the bull market from getting out of control — and keeping it healthy, too.
Comments following the FOMC meeting last Wednesday about its expectations for economic growth and forward guidance on its flexibility to react to economic data regarding interest rates caused some consternation, but then the Fed announced that 29 of 30 banks passed the annual U.S. bank stress test, which was well received. Nevertheless, global investors continue to buy U.S. Treasuries as other countries like China and Japan seek to depress their currencies relative to the dollar. The 10-year yield closed Friday at 2.75% (versus a 52-week high of 3.06% and 52-week low of 1.62%).
Among the ten U.S. business sectors, Telecom, Financial, and Technology were each up more than 2% last week. Utilities is still the leader year-to-date, followed by Healthcare, and these were the first quarter leaders last year, as well. However, Utility stocks are often considered to be substitutes for bonds by income-seeking investors, so any hint of rising interest rates hits this sector, as we saw last week. After showing impressive strength the prior week, the Utilities sector was hit particularly hard on Wednesday and may be forming a bearish double-top on its chart.
Of course, with valuation multiples continuing to climb, the bearish voices are growing louder, with the inevitable comparisons to previous periods of extreme optimism and irrational exuberance. The average P/E for the S&P 500 is now 16.5x on a 12-month trailing basis and around 15.5x on a forward-basis (based on Wall Street consensus estimates, which many consider overly optimistic even after recent downward revisions). However, it seems to me that there are far too many investors who are either betting against this market, steering clear, or raising cash, to conclude that bullishness is over the top.
There is little in the way of pricing power, capital expenditures, or wage growth, as much of the high levels of corporate cash is being used for acquisitions and share buybacks, which help keep multiples under control to some extent — but not in a long-term sustainable way. Eventually, we have to see capital investment in tangible assets like property, plant, and equipment (PP&E) and new hiring to create top-line growth, and there is an expectation among the analyst community that such capex investment is on the way. At the forefront of this anticipated trend is none other than Warren Buffett and Berkshire Hathaway. In his annual letter to shareholders, he reported no share buybacks at current valuations but plenty of investment in PP&E.
