Are these prices justified? Are they sustainable?
These are the questions that are dominating the discourse today, and I want to put them in perspective -- empirically, anecdotally, and perhaps most importantly, emotionally -- to help resolve the answers.
First, we are in an unusual backdrop. Because of the incredible demand for Treasuries from overseas, the combination of a flight to quality and a lack of interest in any of the major other risk-free Treasuries around the globe, our interest rates are lower than they should be.
In other words, given the very good employment growth, including one more incredibly strong jobless claims number today, you would expect rates to rise. Treasuries' rates should be much higher, which would drive other rates higher in a normal situation.
But we are far from normal. Central banks around the world are attempting to debase their currencies so they can get stronger sales. The effort is working in a bizarre way, as 33% of all government bonds around the world today have negative yields. That's right, you earn nothing by buying risk-free Treasuries in many countries.
Not here though. So, of course, there's a scarcity of our bonds and prices are bid up for them, meaning lower rates for all, here.
Of course, the Federal Reserve could raise rates, but then we could have more worldwide turmoil than we already have. It's not worth the gamble.
So there's a phenomenal influx of assets from overseas coming here, keeping rates low - which then makes the dividend yields of stocks much more attractive. So that's an unnatural floor, and it would support the analysis that stocks shouldn't be at these levels, that they aren't justified because their bond competition is artificially low.
Counterargument: So what? So what if interest rates are artificially down? Competition is competition. It's the NFL out there: If you are playing against the other team, and some of their defensive stars are injured, do you asterisk the win if you turn the subs into toast? Do those TDs not count? Only ideologues that hate central banks so much that they wouldn't take advantage of the opportunity would argue that. Sadly, there are plenty of those soapboxers out there. They annoy me. You take it where you can get it.
The second argument that stock prices can't be justified: Based on earnings, they are overvalued, meaning that we are paying too much for these stocks not just based on their dividends, if they have them, but on their earnings power.
I totally get that, if the earnings are going to stay the same or give you meager improvement. But what if the forward earnings are better than those of the past? What if we are just looking into the rearview mirror? That's no way to drive.
I know earnings season is barely underway, but let's look at what we have had this week.
Earnings season started off with Alcoa (AA) on Monday. What did it tell us? That autos and auto exports were much stronger in Europe and China than expected. And that there's newfound demand for trucks in China. We learned that there's more electricity being used and more construction going on.
Further, we got a terrific read on the aerospace industry. Alcoa sees more than just Boeing (BA) , which is clearly losing share to Airbus. Alcoa sees every plane maker, because they have fasteners and proprietary materials in almost all of them. We learned that while there is some short-term inventory workoff -- particularly with wide bodies -- business is very robust, and CEO Klaus Kleinfeld expects to see aerospace grow more than 10% next year. That could be a gigantic acceleration. In the meantime, he expects continued strong growth in U.S. auto production and a nice uptick in construction.
So, let's put it altogether: Autos, trucks, aerospace and construction are all on the increase. Doesn't that imply things are getting better? Doesn't that imply higher earnings? It sure did for Alcoa's stock, which is up substantially from when it reported.
Next, we heard from United Continental (UAL) and Delta Air Lines (DAL) -- two gigantic airlines, both of which came into the quarter down more than 25%.
What did they say? How about that business is better, that it's improving. Hence, a couple of days of monster runs. Airlines are fabulous barometers of consumer spending and commerce. The fact that they had been down so much was pretty daunting to us old-schoolers. To see the run is good verification of what I am talking about.
Too anecdotal still? How about the masterful upside surprise and raised forecast that disc drive giant Seagate Technology (STX) gave on Monday night, the one that took the stock from $24 to $29? Here's a company which has been slicing its estimates for ages. But suddenly business has tightened, average selling prices have improved and the company may be able to continue to pay its gigantic dividend, which now yields 8% -- even after its run.
You get disc drives to do better, you have a whole cohort of techs -- everything from Western Digital (WDC) and Intel (INTC) to Micron Technology (MU) and Microsoft (MSFT) -- potentially doing better. Tech accounts for 20% of the S&P. There's some fabulous pin action off of a Seagate upside surprise.
Then last night we got two more pieces of good news: CSX (CSX) and Yum Brands (YUM) both reported better-than-expected numbers. CSX still has a ton of declining cargos, and we know that coal's just going away -- but it had some good things to say about inventories. More importantly, it expects some of its most important cargos, like intermodal -- those trucks on flatbeds -- to get better next year, and it forecasts positives for auto and construction. Pricing seems resilient. Rails are the definition of commerce in this country, and I felt better after listening to this call.
YUM? All about an improvement in China. I know, I know. I am just talking fried chicken -- and KFC is not a perfect barometer of consumer spending in China. Colonel Sanders doesn't outrank General Tso. But to see a pickup is heartening, especially in light of the strength that Alcoa's Kleinfeld saw.
Then last night, Taiwan Semiconductor (TSC) , which is a gigantic semiconductor company, reported that it had strong cellphone chip demand. Now Taiwan Semi is a huge supplier for Apple (AAPL) -- and naturally traders are reading a positive here, and bidding up the stock of the largest-capitalized company on earth. Apple is a hold of Action Alerts PLUS.
Finally, we had JPMorgan's (JPM) numbers this morning -- and the largest bank saw fabulous growth in consumer and commercial lending. Business was far better than expected. The banks are supposed to be the Achilles Heel of this market. This number sure indicated that things are better, not worse, than you think.
At a certain point the anecdotal evidence piles up to the point where it becomes empirical, and I think these earnings reports potentially justify these stock prices.
Finally let's talk psychological. I remember a long time ago, wrestling with this very question. It was back in September of 1988. I was working with Karen Cramer, and she was running the trading desk. It was Labor Day weekend. I had spent the entire weekend going through everything I knew about stocks, which had just had a terrific run the previous week. I said there was simply no way I could justify the ridiculously powerful move based on earnings. I laid it out point after point just as rigorously as I could, for more than an hour. Her eyes rolled the entire time. She finally said, are you finished? I said yes. She said "Okay, stocks are going up because the companies are doing better than you think. You are looking in the past. The future will be much better. Stop wasting my time." She had a habit of being direct.
We went in that Tuesday and she bought the heck out of the market. It took off. We had a fabulous year, as earnings came in much better than expected. Can these prices be justified? I'm channeling Karen today: Stop wasting my time.
