Well, if we think these people who manage $Trillions of funds are fair dinkum, we should never mention the word Short any more.
Cheapest Stocks in Two Decades Signal Bull Market (Update1)
By Michael Tsang, Daniel Hauck and Nick Baker
April 2 (Bloomberg) -- The U.S. economy is slowing. Mortgage defaults are rising. And stocks are the cheapest in 20 years, a ``buy'' signal for some of the world's biggest money managers.
BlackRock Inc., Fisher Investments Inc. and Schroders Plc, which manage about $1.4 trillion, say stocks are inexpensive relative to bonds. Profit of companies in the Standard & Poor's 500 Index, the benchmark for American equity, is growing faster than shares, and represents a yield of 6.53 percent compared with 4.65 percent for 10-year U.S. Treasury notes.
The gap -- the widest since 1986, according to data compiled by Bloomberg -- is encouraging investors because earnings forecasts indicate the U.S. will keep growing, while bond yields show confidence that inflation will stay in check.
``I'm on the wildly optimistic side of things,'' said Kenneth Fisher, who oversees about $38 billion as chairman of Fisher Investments in Woodside, California. ``The economy is stronger than people think it is.''
Fisher's optimism held through the first quarter even as stocks posted the biggest weekly drop since 2003 in the period ended March 2. They retreated as much as 5.9 percent from the S&P 500's six-year high on Feb. 20.
As many as 2.4 million Americans may lose their homes because of the collapse of subprime lenders and foreclosures, Mike Calhoun, president of the Center for Responsible Lending, a Durham, North Carolina-based nonprofit group, testified to Congress last week.
Lennar Corp., the biggest U.S. homebuilder, reported a 73 percent drop in first quarter profit and said it couldn't give a full-year forecast, two months after predicting this year would be as good or better than 2006. New Century Financial Corp., the second-biggest subprime lender, disclosed a criminal probe.
Earnings Outlook
The S&P 500 withstood a 1.1 percent decline last week to eke out a 0.2 percent gain for the quarter. The index has now advanced in seven of the last eight quarters.
Stocks in Europe and Asia also rose for a third straight quarter. The Dow Jones Stoxx 600 Index added 2.5 percent, while the Morgan Stanley Capital International Asia-Pacific Index advanced 2.9 percent.
Companies in the S&P 500 were forecast to earn $92.76 per ``share'' of the index as of March 30, providing an earnings yield of 6.53 percent, analyst estimates compiled by Bloomberg show. That would be the highest since 1991 when compared with yields based on reported net income.
The 1.88 percentage-point advantage stocks yield over Treasuries is the biggest since at least 1986. The more stocks yield in profit compared with the interest on bonds, the cheaper shares become on a relative basis. This measure was cited by former Federal Reserve Chairman Alan Greenspan in 1997 and is commonly known as the Fed model.
`Stay Invested'
Analysts have underestimated profit growth for S&P 500 members in 13 of the last 15 quarters, data compiled by Thomson Financial showed as of March 23.
``The valuation disparity is big enough that you want to make that relative bet,'' said Robert Doll, who oversees $1.1 trillion as chief investment officer at BlackRock in Plainsboro, New Jersey. ``Our view is `stay invested' because the bull market is not over, because the economic cycle is not over.''
Some investors say the gap isn't enough to keep stocks rising in the face of increasing mortgage defaults, falling consumer confidence and slowing economic growth.
``The issues that we face for the consumer through the housing sector are real, and are going to drag on economic activity for some time,'' said Wendell Perkins, who helps oversee $1.6 billion at Johnson Asset Management in Racine, Wisconsin. ``You could easily end up with a negative year'' for stocks. His $152 million JohnsonFamily Large Cap Value Fund has beaten the S&P 500 for seven straight years.
Surging Defaults
Global markets tumbled Feb. 27 after Greenspan said the U.S. may slip into recession this year. Since then, a meltdown in the subprime mortgage market for loans to borrowers with poor credit histories heightened concern the housing slowdown will spill over to the broader economy and drag down stock prices.
More than 30 lenders have halted operations, gone bankrupt or sought buyers in the past 12 months as defaults on subprime loans surged. Delinquencies on the loans reached a four-year high in the fourth quarter, the Mortgage Bankers Association said.
Concern about foreclosures pushed the Conference Board's index of consumer confidence last month down from a five-year high, while a private report showed home prices declined in January for the first time in at least six years.
Recession Concern
Economists at Morgan Stanley, Nomura Holdings Inc. and HSBC Holdings Plc reduced their first-quarter U.S. economic growth forecasts last week after a report on durable goods orders raised concern a decline in business spending was deepening. Morgan Stanley cut its estimate to 1.6 percent from 2 percent.
The economy grew at an annual 2.5 percent pace in the fourth quarter, the government said in its final revision last week.
Johnson Asset's Perkins agreed with Greenspan's estimate that there is about a one-in-three chance of a U.S. recession this year. Stock indexes may fall at least 10 percent if that happened, Perkins said.
For BlackRock's Doll, valuations are attractive enough to help keep the rally in U.S. stocks from derailing. Doll cited the Fed model as one such measure.
Doll is also confident a slowdown caused by the housing slump will give the Fed more incentive to spur economic growth by cutting borrowing costs. He forecasts the S&P 500 will climb to 1549 by year end, implying a 9.2 percent gain in 2007.
`Inevitable March'
The S&P 500 had the biggest weekly jump in four years, rising 3.5 percent, after investors interpreted the Fed's statement on March 21 to mean the central bank's policy makers abandoned their bias toward raising U.S. borrowing costs.
The Fed dropped a reference to the potential for ``additional firming'' in interest rates, language repeated since it ceased two years of increases in August. Last week, Fed Chairman Ben S. Bernanke clarified the central bank's position by saying that while inflation remains his main concern, ``a little more flexibility might be desirable'' in monetary policy.
Traders expect about a 60 percent likelihood the Fed will cut its benchmark rate by a quarter-point to 5 percent in August, according to fed funds futures. The central bank has left its overnight lending rate at 5.25 percent since August.
According to the median forecast of 73 economists Bloomberg surveyed from March 1 to March 7, the Fed will cut its rate to 5 percent in the fourth quarter.
``The phrase I've been using is that `the Fed has been and will continue to be on an inevitable march to lower their target rate,''' BlackRock's Doll said.
More Bullish
Jim Paulsen at Wells Capital Management is more bullish, saying stocks will advance even without rate cuts by the Fed.
He credits the cheap valuations of shares for helping spur the latest rebound. The same reason has kept almost all retreats during the four-year rally from reaching 10 percent, he said.
The only such ``correction'' took place between Nov. 27, 2002, and March 11, 2003. The S&P 500's 15 percent decline during that span coincided with the run-up to the U.S. invasion of Iraq on March 19 that year.
A week before the bull market began in October 2002, shares of companies in the S&P 500 traded at 26.5 times reported profit. Now, the price-earnings ratio, or the inverse of the earnings yield, stands at 17.1 times.
``Earnings have chronically grown faster than stock prices,'' said Paulsen, who oversees $175 billion as Wells Capital's chief investment strategist in Minneapolis. ``That is certainly contributing to the oddity of no big corrections.''
He expects the S&P 500 may reach at least 1600 this year, which represents a 13 percent gain for 2007.
Drop in Yields
Russ Koesterich, at Barclays Global Investors in San Francisco, which has $1.7 trillion in assets, says the Fed model overstates the value of stocks when bond yields are as low as they are now. The lower yields go, the higher the implied value of stocks, even though equities may not be worth more when the economy slows, he said.
While stocks are the cheapest versus bonds since at least 1986, yields on 10-year Treasuries are 1.56 percentage points lower than the monthly 6.21 percent average in the past 20 years.
The S&P 500 would have to climb to 1791.21 to be fairly valued relative to bonds, or a 26 percent increase from last week's closing price of 1420.86, based on the Fed model. For the index to equal its all-time closing high of 1527.46 in March 2000, it needs to rise 7.5 percent.
``There are limitations to the Fed model when interest rates are this low,'' said Koesterich, who views stocks as neither overly cheap nor expensive relative to earnings. ``Basically what happens is you start to come up with some absurd valuations.''
`A Little Hysterical'
Koesterich says a gain of 10 percent to 12 percent for the S&P 500 this year will hinge on the Fed cutting rates and the housing slowdown remaining ``pretty much limited to subprime.''
For AIM Investments' Fritz Meyer, concerns about the housing market are overblown. He sided with Bernanke's assertion that the economy will continue to ``expand at a moderate pace'' and defaults and delinquencies among subprime borrowers won't stanch demand for mortgages to more qualified home buyers.
Concern about subprime ``got a little hysterical,'' said Meyer, the Denver-based senior investment officer at AIM, which oversees $149 billion. ``Stocks can and should do pretty well, absent the economy slipping closer to recession, which I don't expect.''
Fed officials forecast in February growth of 2.5 percent to 3 percent this year and 2.75 percent to 3 percent in 2008.
More Incentive
The widening gap between what companies yield in earnings and the cost of borrowing gives buyout funds, which have an estimated $1.6 trillion to spend, more incentive to take companies private, according to Schroders' Alan Brown.
That will help turn any sell-off into a buying opportunity, as mergers and acquisitions help shore up demand, he said.
About $593 billion in takeovers involving U.S. companies have been announced this year, 44 percent more than the $411 billion of deals announced during the same period last year, according to data compiled by Bloomberg.
``As long as earnings yields are staying well north of financing costs, there's an absolute wall of private-equity money looking to get employed if stock prices start retracing,'' said Brown, who oversees $229 billion as Schroders' head of investments in London. ``Even if the negative story comes more to the fore, it should give one some encouragement.''
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