Through all the noise and the nuttiness and negativity it is hard to remember exactly what kind of environment drives stocks higher.
As we dwell at the highs for the year now, let's go over what allows us to get there -- the backdrop that gives us higher prices for the overall market and, in particular, this market at this moment in time.
First, the investors like to see low inflation. When you see low inflation that means the long-term value of stocks, the future earnings streams you are buying, are going to be preserved. When you have high inflation it erodes that value.
Last Friday we got an employment number that signaled that there is no inflation at all in the system other than the mandated inflation that comes from higher minimum wages. I cannot even begin to tell you how important low-to-no inflation is for the value of the stocks you own, other than to remember how awful stocks have been when inflation rages.
Now, I know that there's nothing to cheer about when it comes to wages for the vast majority of Americans and the minimum wage impacts far fewer people than it used to.
That said, tame inflation means that all stocks are worth more so even if you hear that the stock market is expensive, it may not be as expensive as it seems given that inflation's not making it so the payments you get from dividends or increases in share price in the future are worth less than you hoped they would be.
Second, the competition for your stocks, the bond market, just can't measure up in an environment when the Federal Reserve doesn't mandate higher yields. That means all of those stocks that pay good dividends, the ones north of 3%, are so attractive. Let me show you how important this can be. Take the stock of Caterpillar (CAT). Here's a company hedge fund managers routinely bash because of its exposure to weak areas like mining, oil exploration, coal and Chinese infrastructure. It's perhaps the most shorted, or bet against, of any major company I follow.
But the company, as poorly as it might have performed, yields 4% and the company does have the money to pay that dividend. So, even though the near-term prospects are poor, the yield searchers love it and that's not going to change now that Janet Yellen took off the table any chance of a near-term rate rise.
Second thing the bulls always want to see? The dollar going down.
I have said to you over and over again that as the dollar goes, so goes the market. With the Fed on hold, foreigners are not going to be seeking out dollars as they would be if we had rate increases. I know the percentage return you get on your savings isn't anything to write home about, but if you are earning no interest on euros in a German bank, why not buy dollars and stick your money in an American bank? You would do that if you knew that there was more to gain from putting money here, namely higher rates, but that employment report eliminated any hope of a near-term dollar appreciation. That's phenomenally important because we are now going into a period where the dollar is unchanged year over year.
When companies report they will no longer have to explain why you should ignore the numbers because the dollar's so strong. That excuse is gone. In its place are goods that are priced more competitively to the overseas customers and earnings that are worth a lot more when they are translated back into weaker dollars.
That's how an international companies like Johnson & Johnson (JNJ) and International Flavors & Fragrances (IFF) can hit all-time highs as they compete with other international companies and reap the benefit of both a competitive advantage with a weaker dollar and more money left after the translation back into dollars. That's how 3M (MMM) is able to break out above $171 as it's a gigantic international company that competes against foreigners everywhere as does Honeywell (HON), another winner in a weak dollar world.
Finally, third we want to see higher oil prices because that things are getting better worldwide. Now, a lot of the price increase off the bottom in February has come from a cutback in supply, but the Saudis, who are in charge of pricing now that OPEC's pretty much ceased to have relevance, are telling people that Chinese and Indian demand are now stronger than they have been. Makes sense. We just learned that GM's (GM) selling a huge number of cars in China recently. That's demand on the face of it.
The oil stocks carry a disproportionate amount of weight in this market because there are so darned many of them. Lots of them have humongous amounts of debt and their own problems have hurt the lenders, typically the big banks, many of which went hog wild lending to every oil company and its brother. When the price of oil goes higher, these companies can sell their oil for more money, which then allows them to pay back their debts, which then causes the bank stocks to do better even as you would expect them to perform poorly with rates so low. Oil stocks like Pioneer Natural (PXD), Cimarex (XEC) and Anadarko (APC) are the tails that wag the market's dog.
At the same time, the strength in the oils tells a tale of strength in the rest of the economy and that's even being reflected, counterintuitively of course, in the first rally in the airlines in ages, one that may have staying power.
Now, on any given day there are going to be some party poopers to the thesis. We had Joe Papa on recently, the new CEO of the beleaguered drug company Valeant (VRX) and the company reported some disappointing numbers. Apparently the competition took advantage of the disarray in their skin and eye-care divisions. You know that JNJ and Allegan (AGN), both up against Valeant, are doing their opportunistic best to eviscerate a sworn enemy. At the same time, Papa told us he had to do some price rollbacks, something that doesn't make for a good bottom line. Perhaps Papa is just setting the stage for the ultimate in reduced expectations so he can over-deliver on his under-promises. Or, perhaps, it's just much worse than he thought when he came on the show. We don't know. We have to wait a couple of quarters to find out.
And there's Ralph Lauren (RL), the clothing company, which slashed is estimates and told a dire story of layoffs and tough love as the mall keeps mauling retailers. Sometimes the stock market judges companies too harshly. I wanted new CEO Stefan Larsson, who did a fantastic job turning around Gap's (GPS) Old Navy division, to bite the bullet and really cut both overhead and excess capacity. We are overstored and you can find Ralph Lauren's stuff in too many places. When the stock was in the hundreds and not prepped for this tough love, I would understand the viscerally negative reaction. But down here in the $80s and $90s, give me a break. This is one fabulous brand and I think it can come back in a quarter or two.
But in general, when you have the basics working for you, not against you, investors find reasons to throw money at the market and right now it sticks on the stocks with the best international stories.