Wall Street strategists vs. analysts: who to believe…


…what to do with your equity portfolio now.

The S&P 500 made an another all-time high yesterday.  Now at 1650, the index has already made greater gains than any professional I’m aware of had predicted for the entire year.

Analysts say the market will be higher in 12 months.  Strategists say the opposite.

What to do?

earnings aren’t the issue 

Stocks are reasonably valued at 15x 2013 earnings and less than 14x next year’s.  They’re not as cheap as they were at the bottom in 2009, but they’re not wildly expensive either.

The traditional comparison with the other big class of liquid investments–government bonds–is to measure the 30-year Treasury bond yield against the earnings yield (that is, 1÷PE) on stocks.  On this measure, stocks are already trading as if the long bond were at 6.5%.  This suggests that most, if not all, of the eventual rise in bond yields that will occur when the Fed returns interest rates to normal, is already factored into today’s stock prices.

earnings growth isn’t the issue

Both analysts and strategists think that corporate profit growth will accelerate from here and reach about a 10% year-on-year rate of advance in 2014.  (By the way, the 10% figure is not itself a very controversial one.  It describes an average year.  It’s also the figure I’d start with as the most likely outcome, and move up or down depending on whether I felt strongly positive or negative.)

the issues?

Stock investors seem to me to be vaguely uneasy that the market has gone too far too fast.

It’s a little scary that retail investors who sold in 2008-09 are only now–after a four-year, 140% rise in the S&P 500–putting their money back into stocks.  Arguably, when blunted pencils start moving into the box, it’s time to move on.

Saying the same thing in a different way, the current rally isn’t based on the fact that corporations are reporting surprisingly good earnings.  Rather, the market’s price-earnings multiple (the price people are willing to pay for a unit of earnings) is rising.

More relevant, in my view, is the worry that as the Fed raises interest rates from today’s ultra-low levels the resulting fall in bond prices will have a negative effect on stocks.


We can interpret the PE expansion the market is undergoing as simply a return to more normal levels after years of recession-induced fear.

The eventual rise in interest rates will be preceded by strong corporate earnings growth, which will mitigate the negative effects of higher rates.  That’s perhaps the biggest lesson world central bankers have taken from the quarter-century of economic misery in Japan, where the government nipped economic recovery in the bud twice, by tightening prematurely.

In similar instances of Fed rate-raising in the past, stocks have gone sideways to up.

We’re very close to the time of year when in normal times Wall Street begins to look at, and discount in current prices, earnings prospects for the following year.

The technical tone of the market remains bullish.

what I’m doing

My inclination is not to make major portfolio changes but to do routine maintenance instead.

Specifically, I’m:

–going through my holdings, position by position, and asking if the reasons I established it are still valid, and

–checking position sizes, to make sure none are so large they pose a risk, or too small to do any good.

finding clunkers

Everyone has blind spots.  And everyone has clunkers that his eyes somehow skip over when doing a portfolio check.  One way I’ve found to help myself to see these “invisible” losers is to imagine that I’ve got to raise, say, 10% cash immediately.  What would I sell to do so?  Unfortunately, but not unexpectedly, one or two problem cases pop up.

Any money I “find” this way I’m probably going to take my time putting back into the market.  That’s as much defense as I usually do.  And it’s all I’m going to do now.

corrections are a fact of life

At some point, the S&P is going to fall by 5% – 10%.  That’s just the way stocks work.  This is a worry for day trades.  But for investors–especially one who are doing routine portfolio maintenance and culling losers–this shouldn’t be a concern.






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