The rally that added $1.95 trillion to U.S. equity values since July is telling Laszlo Birinyi and Kenneth Fisher that the new normal era of slower economic growth and lower stock returns has yet to arrive.
Mining shares led by Freeport-McMoRan Copper & Gold Inc., automakers and retailers whose earnings are most tied to the economy have paced the 16 percent advance in the Standard & Poor's 500 Index since July 2, data compiled by Bloomberg show. The gauge surged 12 percent in September and October, the biggest rally for the two months since 1998. The U.S. economy grew at a 2 percent annual pace in the third quarter, the government said Oct. 29.
Pacific Investment Management Co., which oversees the world's biggest bond mutual fund, said in May 2009 that rising government deficits and regulation would hold gains in equities and bonds below historical averages. Mohamed El-Erian, Pimco's co-chief investment officer, said last week that his projection has a 55 percent chance of coming true.
“Of the leading economic indicators, one of the most important is the stock market,” said Birinyi, whose Westport, Connecticut-based Birinyi Associates Inc. advised clients to buy stocks when the S&P 500 began rising from a 12-year low in March 2009. “The market's saying something, and it's saying the economy is going to be surprising on the upside.”
Growth Proxy
Birinyi recommended clients buy Freeport-McMoRan, the largest publicly traded copper producer, and Diamond Offshore Drilling Inc., the biggest U.S. deepwater driller, as part of his model growth-stock portfolio. The 10 companies in his basket for investors seeking the fastest profit increases averaged returns of 8.3 percent in the past month and have gained 17 percent for all of 2010, according to an Oct. 27 statement from Birinyi Associates, which oversees about $200 million.
Freeport-McMoRan, which surged 62 percent since July 2, is an indicator of economic expansion, according to Birinyi. The company's third-quarter earnings topped analysts' estimates on Oct. 21, the ninth straight quarter of better-than-projected profit. Houston-based Diamond Offshore has gained 16 percent from its low on June 8.
Bill Gross, the co-chief investment officer of Pimco whose Total Return Fund makes up 20 percent of the firm's $1.24 trillion under management and has climbed 11 percent in 2010, wrote on May 26 that government budget deficits would hold down growth as lending capital disappears.
“Investors must respect this rather tortuous journey in the months and years ahead for what it is: A deleveraging process based upon too much debt and too little growth to service it,” according to a letter on the company's website.
Subject to Change
El-Erian said last week that the firm hasn't ruled out different outcomes.
“Like all our analytical work, the new normal scenario is subject to continuous refinement to incorporate new information and analysis,” El-Erian, who is Pimco's chief executive officer. “Upside risk scenarios speak to the possibility of a faster coming on stream of consumer demand in emerging economies and the return of full policy effectiveness in the U.S.”
Futures on the S&P 500 climbed 0.6 percent to 1,186.3 as of 10:51 a.m. in London. The gauge was little changed last week, ending at 1,183.26, as optimism about earnings was tempered by concern the Federal Reserve won't do enough to stimulate the economy. The Commerce Department's gross domestic product report showed the core personal consumption expenditures price index, which strips out food and energy costs, climbed at a 0.8 percent pace, down from 1 percent the prior quarter.
Starting Points
The benchmark gauge for American equity is up 6.1 percent this year, data compiled by Bloomberg show. U.S. government bonds have returned 8.3 percent this year, including reinvested interest, and investment-grade corporate bonds gained 12 percent, according to Bank of America Merrill Lynch indexes.
An investor who bought the S&P 500 at the market bottom in March 2009 has an annualized gain of 44 percent, data compiled by Bloomberg show. Purchasing when the index reached its record high in October 2007 means an annualized loss of 6.7 percent. U.S. equities have returned 6.2 percent a year since 1900 before dividends, according to inflation-adjusted data compiled by the London Business School and Credit Suisse Group AG in Zurich.
Gluskin Sheff & Associates Inc.'s David Rosenberg says the rally since July isn't sustainable. The S&P 500 is near the high end of its trading range, and neither the Federal Reserve's second round of Treasury purchases nor tomorrow's election will save equities, he said.
Policy Solutions
The “speculative rally” is based on delusions the Fed will succeed, Rosenberg, who was ranked the No. 2 economist by Institutional Investor magazine in 2008, wrote in an e-mail to Bloomberg News. It's an “‘Ugly Duckling' economy which needs really effective policy solutions.”
The U.S. unemployment rate of 9.6 percent is 3.9 percentage points above its average since 1948, according to data compiled by Bloomberg.
At the same time, equities have continued to rally. The relative performance of transportation companies is another signal of sustainable economic growth, according to ING Investment Management's Paul Zemsky, whose firm oversees $550 billion worldwide. The Dow Jones Transportation Average has risen 16 percent this year, compared with a 6.6 percent gain in the Dow Jones Industrial Average.
United Parcel Service Inc. in Atlanta raised its annual profit estimate on Oct. 21 after posting an 80 percent third- quarter income gain on higher international shipments. The world's largest package-delivery company is up 19 percent since July 2. Memphis, Tennessee-based FedEx Corp., the biggest cargo airline, has climbed 23 percent.
‘Making a Mistake'
“You need those stocks to do well for an economic recovery to be durable,” because truckers, railroads and airlines usually gain business before the economy accelerates, said New York-based Zemsky, the head of asset allocation for ING. “People who are counting the U.S. economy down and out are making a mistake.”
The S&P 500 has risen 11 percent since Fed Chairman Ben S. Bernanke indicated during an Aug. 27 speech in Jackson Hole, Wyoming, that he may be willing to pump more money into the economy.
“The stock market has always been and continues to be one of the better leading economic indicators,” said Fisher, whose Woodside, California-based Fisher Investments Inc. oversees more than $38 billion. “To knock the market down, you'd have to have a new big, bad thing. Could it happen? Yes, it could. Is it likely? I don't think so.”
Modest Growth
The Fed bought about $1.73 trillion in government debt and mortgage securities in a 2009 program to keep interest rates near record lows, support securities prices and bolster the housing market. Since Aug. 17, it purchased another $62 billion of Treasuries, and has been weighing more monetary injections as its Beige Book business survey released Oct. 20 reported that the economy grew at a “modest pace” in September.
Elections tomorrow may divide power in Congress, helping the market, Fisher said. There's a 92 percent chance Republicans will take control of the House of Representatives, helping them block President Barack Obama's policies, according to bets on Intrade, a Dublin-based online prediction market.
“The stock market is just showing that maybe it's not as bad as what a lot of people think,” said Liz Ann Sonders, the New York-based chief investment strategist at
Charles Schwab Corp., which has $1.5 trillion in client assets.
