Jim Paulsen of Wells Capital
I’ve written about Dr. Paulsen a couple of times before. He’s an experienced and skilled commentator on the US economy and on financial markets. I think he’s well worth reading.
My only worry is that his optimistic views often parallel mine. On the one hand, it’s comforting to see that you’re not alone in your thinking. On the other, any investor must fight the temptation to pay attention only to people who agree with you.
Wells Fargo also has a pro-active PR department. I’ve been on Dr. Paulsen’s mailing list since the first time I mentioned him in PSI.
an important insight
His basic idea, one I agree with, is that the world has changed a lot since the 1970s and 1980s. Therefore, comparing the current economic recovery to ones from way back then is wrong. Nevertheless, that’s what most economists do–and conclude that this recovery is unusually slow.
If, however, we compare today with the situation after the recessions of 1990 and 2000, the recovery looks perfectly normal. It’s slower than we’d like…but so too were the previous two.
Paulsen’s 2/12 newsletter
In his February 2012 Economic and Market Perspective, which wasn’t yet on the Wellscap website as I’m writing this, Dr. Paulsen goes into detail about the third year of a “modern” recovery, which he calls the “Gear Year.” It isn’t necessarily about explosive earnings growth–that was the story earlier in 2010 ans 2011. It’s all about restoration of confidence.
Consumers finally become convinced that we’re not going to slide back into recession. So,
–bank lending increases rapidly
–housing beings to perk up
–consumer durables purchases, especially autos, accelerate.
That’s all happening now.
financial market implications
In Paulsen’s view, Wall Street was willing to pay 15x current earnings for stocks last year, until semi-crazy fears that recession would recur and/or that Europe would implode clipped 15% or so off that. Earnings per share, at around $100 for the S&P 500, were unaffected. The mid-year market swoon was all about (lack of) confidence and about resulting contraction in the multiple of earnings investors were willing to pay.
This year, the S&P 500 will earn something north of $100/share. The cyclical return of confidence will cause the market’s PE multiple to expand as well. This makes 1500, or about 10% higher than the current index level, a reasonable target. Because the domestic economy will grow at 3%+ (a higher rate than the consensus expects), cyclical sectors will lead the way. Defensives will lag.
Stocks whose main attraction is the dividend are a particular worry, because…
Stronger than expected growth in the US and less damage emanating from the Eurozone together mean that the Fed will have to reconsider its zero interest rate policy much sooner than it has been planning. This year, in fact. In Paulsen’s view, the 10-year government bond yield may reach 3.5% by December. That will dim the luster of dividend stocks.
I have some minor quibbles with Dr. Paulsen, but they don’t change the overall outlook. He’s a tad more bullish than I am (hard to do for most people). But the US is healing itself, and we may well be at a positive inflection point for investor confidence.
Two related points:
–3.5% is only a way station for the 10-year Treasury. The Fed thinks a neutral Fed Funds rate is 4%+. That would mean a 10-year yield above 5%.
–how will rising rates affect securities? Bonds will suffer; the longer the maturity (or the longer the duration, a topic for another post), the worse the damage.
Stocks, on the other hand, have two defenses. True, rising rates are a negative for the stock market. But interest rates will start to rise because the economy is picking up and no longer needs low-rate life support. That means profit growth will be accelerating. Returning confidence may mean a higher multiple placed on these earnings, as well.
I wrote about this phenomenon about two years ago. The post is a bit outdated and the “normal” interest rate figures I’d been estimating then are too low. But the basic points are still valid, I think. Most important, I have a chart showing S&P 500 behavior while interest rates are rising during economic recovery. In the past, the market has always gone up while this is happening.