Market Commentary, April 2013

Are Stock-Market Highs Reasons to be Excited?
by Ron Muhlenkamp, originally published in the Pittsburgh Business Times, April 12, 2013

As usual, there are conflicting pressures on both the marketplace and the economy. Over time, economic growth is good for both, but growth in the marketplace often leads growth in the economy. The trouble is that growth in the marketplace is also subject to false starts. And, of course, both the stock market and the economy are measured in dollars—which is itself an elastic yardstick; (in 1968 dollars, I’m 46 feet tall). Because our dollar yardstick shrinks at the rate of inflation, today’s “nominal” dollar is worth less than the dollars of the past. Specifically, at the 2% rate of inflation, both the economy and the markets must grow at 2% per year just to break even in real terms.

Point #1: The new highs are not really new highs.

Our economy is normally measured by Gross Domestic Product (GDP). Our GDP has exceeded the prerecession (2007) highs in both nominal and real terms, although not in real dollars per capita; (our population grows about 1% per year). Of the various components of GDP, retail sales have exceeded the old highs; capital spending and employment have not. Capital spending and employment are “lagging indicators.” Their recovery normally lags broadbased GDP, but nominal GDP bottomed in June of 2009. It’s now four years later. Note that capital spending and employment require decisions by businessmen, decisions which require confidence in future sales and profitability. And sales growth has been slow. Because of the slow growth in sales since 2009, companies have been able to meet demand through a focus on productivity, allowing company management to delay decisions on employment and capital spending, pending clarification of

Point #2: Employment and capital spending are well below the old (nominal) highs.

The bond and the stock markets have also received a major assist from the U.S. Federal Reserve. The Fed has stipulated continued low interest rates, initially at the short maturities, but then, extended to the longer maturities through the buying of long-term treasuries and mortgage-backed securities. Of course, this drove bond prices higher, but has also had the effect of driving stock prices higher as well. The Fed has done this purposely, believing that higher stock prices, in and of themselves, will have a positive effect on the economy. We’re about to find out if this is true. Point #3: If low interest rates and money infusions into the banks are sufficient to offset the higher costs of employment, the economy will grow nicely from here. If not, the risk is that the market prices of stocks get (or are) ahead of the economy.

So am I excited? It feels more like concerned.