Stock Market at Record Highs…April Fool’s?
Article is an excerpt from previously released Sidoxia Capital Management’s complementary April 1, 2013 newsletter. Subscribe on right side of page.
April Fool’s Day has been around for centuries and has provided an opportunity for foolish pranks to be played on the masses around the world. Evidence of the global practice can be found from the bumper spaghetti harvest in Switzerland filmed by the BBC in 1957. The video footage (click here) was so convincing, viewers called and asked how they could grow their own spaghetti.
A cruel prank has also been played on investing skeptics as they have watched the S&P 500 and Dow Jones Industrials indexes catapult to new record highs over the last five quarters (up +25% & +19%, respectively). How can the stock market be setting new records when we have recently experienced a fiscal cliff, sequestration, a deepening European recession, slowing corporate profit growth, anemic GDP (Gross Domestic Product) expansion (0.4% last quarter), and a $13 billion Cyprus bailout?
The short answer is the economy continues to improve at a steady pace; stock prices are attractive; and gloomy headlines sell more advertisements in newspapers, magazines and on television. Is this wealth explosion a practical joke, or how can we help better explain this surprising phenomenon?
1) Record Corporate Profits
Corporate profits are at record levels. After the worst financial crisis in a generation, companies have become mean and lean. They are hiring cautiously to maintain healthy profit margins, but also investing into productivity-improving technology and equipment.
2) Record Dividends and Share Buybacks Galore
Annual dividend payments have reached a record level of more than $300 billion for S&P 500 companies, and there are no signs of this trend slowing down. This is occurring just as interest rates on bonds have been continuing to decline. Tack on a few hundred billion dollars in share buybacks to boost stock prices, and you get a recipe investors are enjoying.
3) Housing on the Comeback Trail
Housing accounts for a significant portion of our economy. After several years of depression-like activity, this sector is on the comeback trail. In fact, the S&P/Case-Shiller index, that measures home prices in 20 major metropolitan cities, rose by +8.1% in the most recent reported figure. This increase was the largest gain in six-and-a-half years. This is important because the improvement in housing filters through to other major sectors of the economy, such as retail (e.g., furniture), banking (e.g., mortgages), and government (e.g., property taxes).
4) Consumer Spending Can’t be Killed
Like a cockroach, the consumer is tough to exterminate. Consumer spending accounts for roughly 70% of the economy’s goods and services, and as you can see from the chart above, people are still shopping – despite domestic and international challenges.
The net result of all these trends is that the economic picture continues to improve and consumers and investors alike are beginning to feel better about themselves. And how could they not? As evidenced by the chart below, household net worth has reached a record level of about $66 trillion dollars, thanks to rallies in the stock market and home process, combined with a renewed conviction of keeping debt in check.
Cyprus Side Notes
Over the last month, an avalanche of headlines, relating to the dire financial condition of Cyprus and Cypriot banks, has cascaded across the major media outlets. In analyzing the situation, there were two major questions I wanted answered:
Question #1: What is going on in Cyprus?
As it relates to this tiny island, approximately the size of Puerto Rico (east of Greece and south of Turkey), the first thing I learned is that the Cyprus situation is another example of a country’s financial sector gone wild. By some estimates the size of Cypriot bank deposits were more than 4x’s the size of its GDP. A key driving force behind the oversized banking industry is Russian depositors, who make up about 1/3 of overall Cypriot banking deposits. Cyprus acted as a sort of Cayman Islands in the Mediterranean for these wealthy Russians, who moved billions of dollars to the island after the Soviet Union broke apart in the early 1990s. The main attraction for the Russians were the lax banking laws and generous tax advantages.
In order to clean up this financial mess, the so-called adults or Troika, made up of the European Central Bank (ECB), International Monetary Fund (IMF), and European Commission (EU legislative body), approved a $13 billion bailout for Cyprus on the condition they restructured their main banks (Laiki Bank to be merged into Bank of Cyprus). The end result is that Cyprus (like Greece) chose to take the harsh medicine and stay in the eurozone by combining/closing banks and instituting significant losses on those depositors with more than $130,000 in their accounts (with some depositors expected to lose -60% of their money).
Question #2: Should I care?
The short answer is “No”. With a population of about 850,000 people, Cyprus is home to about the same number of folks who live in Birmingham, Alabama. Moreover, the size of Cyprus’ economy is barely 0.2% of euro-land GDP. Many pessimistic bears acknowledge the infinitesimal size of the Cypriot economy, but position the country as the domino about to topple the rest of Europe, including the much more important countries of Spain and Italy. The fact that private depositors are feeling a larger brunt of the pain rather than public taxpayers is actually a healthy long-term trend that will force more responsible behavior by other European financial institutions outside Cyprus.
In the face of the noisy Cyprus sideshow and endless economic/political worries, our corporate profit machine continues to churn out escalating profits,
as our stock markets set new record highs and our economy gains momentum. Today may be April Fool’s Day, but don’t become bamboozled by silly diversions, this stock market is no joke.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing SCM had no direct position in any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Entry filed under: International, Themes - Trends. Tags: April Fool's, April Fool's Day, Case Shiller, corporate profits, Cyprus, dividends, housing market, Laiki Bank, retail sales, Russia, share buyback.