The price-to-peak earnings multiple increased to 12.0x as of last week’s close. Reported macroeconomic data was generally positive over the last week with positive surprises coming from the ISM manufacturing index and pending home sales data. Same-store sales rose for the second straight month which stoked hopes of stabilization in consumer spending. However, comparisons to the third quarter of 2008 were expected to be favorable given the horrendous plunge in spending following the collapse of Lehman Brothers. Also, productivity surged for the second straight month leading some economists to speculate that corporations might consider hiring more workers in order to take advantage of more profitable man hours. However, the unemployment rate exceeded the10% benchmark as jobs lost in October were slightly worse than expected at 190,000.
The FOMC also announced that it would leave interest rate targets at their historically low levels for quite some time, based on the belief that continued quantitative easing will engender economic recovery. However, this suggests to us that the Fed lacks confidence in the durability of the economy in a more normal rate environment. It appears that Bernanke and the rest of the FOMC are not yet ready to remove the “training wheels” aiding the economy’s forward progress. Investors seem to believe that the ongoing devaluation of the dollar is generally a positive for stock prices, so equities could indeed continue higher with the dollar’s swoon. But, as David Malpass wrote in his Op-Ed in the WSJ in August, devaluation of currency has never led to long term prosperity and this sort of policy is ultimately a tax on every American as purchasing power is eroded.
The percentage of NYSE stocks selling above their 30-week moving average rose to 82% this week. As you can see, our investor sentiment data remains elevated as the bulls regained control last week following two weeks of market losses. Last week, the market took its cues from the biggest bull of them all, Warren Buffett. The “Oracle of Omaha” sees great opportunity in this market and is betting heavily on the transport sector with his acquisition of railroad operator Burlington Northern Santa Fe (BNI). The transaction, which totaled about $44 billion, will be the largest in nominal terms that Buffett’s Berkshire Hathaway
(BRK.B) has ever completed.
The transport sector is highly correlated to the strength of the underlying economy as it carries to market the goods that fuel economic activity. Buffett, long a proponent of railways, must see emerging trends that portend a robust recovery for the U.S. Merger and acquisition activity is certainly heating up again, which, in our view, is a net positive for investors as corporate managers are seeking bargains and looking for cost synergies.
The last week’s stock market gains showed the impressive resilience of investors and we believe it also exposed what is currently driving stocks higher. Bad news in the labor market was brushed aside in favor of the Fed’s statements as they relate to rates over the next few quarters. The market loves to hear that the rates will remain low as it should allow capital to flow more freely. At the same time, as the printing presses continue to chug away, the dollar declines, making U.S. exports more attractive in overseas markets. The market view this as a net positive in the short- and medium-term time frames, but we continue to believe that the Fed is walking a very fine and perilous line. The government is spending huge sums of money and bills working their way through Congress that would spend even more. Now there are even rumblings about the need for a second stimulus! Policy makers need to remain vigilant that the quantitative easing does not get out of control, even as some argue that this has already occurred. An interesting side note, the Indian government last week made a huge purchase of gold with some of their fiscal surplus. This is significant since some of that money would almost certainly have previously been used to purchase U.S. Treasuries. India’s decision to diversify away from or hedge against the dollar is worth noting. We will continue to monitor this trend as the Chinese have been diversifying their reserve holdings into commodities as well.
