We recently passed the five-year anniversary of the market's trough due to the financial crisis. On March 9, 2009, the Dow Jones closed at 6507.04; the S&P 500 closed at 676.53; and the Nasdaq closed at 1268.64. On March 10, 2014, the Dow closed at 16,418.68; the S&P 500 closed at 1877.17; and the Nasdaq closed at 4334.45. These respective gains are all quite impressive over that time frame. However, if we go back to the 2007 peaks of the each benchmark (around October 9-10), we get a very different picture. The annualized returns (through March 10, 2014) since then are 2.30%, 2.84%, and 6.76% respectively.
Based on some recent conversations I've had, I thought it may help to expound on why I am (along with many others) cautiously optimistic about the US stock markets.
Labor Markets
As of their February 2014 report, the Bureau of Labor Statistics (BLS) shows a year-over-year decline in the unemployment rate from 7.7% to 6.7%, which reflects about 1.6 million people back in the workforce. The headline numbers have clearly improved, though at a sluggish pace. There are concerns, however, when you delve into the report for details.
- 10.5 million Americans counted as unemployed;
- 7.2 million people employed part-time for economic reasons ("involuntary part-time workers");
- 2.3 million people "marginally attached to the labor force", meaning that they were not counted as unemployed because they had not searched for work over the four weeks prior to the survey for this report. Roughly 1/3 of this group is considered "discouraged" as they are neither looking for work nor do they believe jobs exist for them.
- If we include the unemployed, underemployed, and those not being counted, we would be discussing 12.8% of the labor force, not 6.7%. As this employment picture slowly improves, it could mean that there is a possible modest tailwind for the economy until these figures become historically normalized.
Consumption - Is the trend my friend?
Corporations Sitting on Cash
During this recovery, corporations have used cash for share buybacks, enhancing dividends, or for mergers & acquisitions rather than hiring people back at a faster rate. The reasons for this range from the lack of visibility regarding corporate taxes to sluggish consumer demand. In 2013 alone, revenue growth for the member companies of the S&P 500 was approximately 2.24%, but operating earnings are estimated to have grown more than 9% (mostly due to the effect of cost cutting over the last few years). We're all waiting for top line growth, but this is truly a "chicken and egg" scenario. Companies won't hire until there is greater consumer demand; consumers demand won't increase until wages begin to increase. Wages won't increase until companies hire and the labor market tightens.
Janet Yellen & the Federal Reserve
The pace of the Fed's economic support reduction ("tapering") is critical moving forward. In my opinion, while the unemployment rate is approaching their stated target, the degree of slack in the labor markets and lack of any inflationary concerns indicate that tapering will occur at a measured pace pending signs of economic acceleration. Their actions will most likely become more swayed by qualitative information than quantitative. As I write this, the Fed is scheduled to conclude their meeting this afternoon, and make an announcement afterwards. More to come on this at a later date.