EmailStretching for subject matter given the overwhelming presence of the undeniable reality that nearly un-analyzable European debt considerations swamp value and fundamental stock market arguments (and choosing not to revisit that subject), your author falls back on the increasingly popular journalistic trick of presenting a list of top issues for your consideration.
Herewith, my top five pet peeves regarding market analysis of current conditions.
Number One: Calling this a Bear Market and a Recession
It may feel like a bear market. It may feel like a recession. That doesn't make it true.
It is true that the S&P 500 has not rebounded to its highs of 2007. It is also true that the S&P 500 is up 37% over the past three years. That isn't a bear market.
Calling this a bear market misrepresents the current trend in stock prices.
There are implications. Dwelling on the losses from years ago obscures the opportunities of today. Investing in high-quality, dividend-paying stocks has been profitable over the past few years. The past three years literally have been one of the strongest bull markets in decades.
It is totally reasonable to forecast a down market in the year ahead, but to support that argument by saying this is a bear market is deserving of scorn.
Similar analysis applies to the economy. Real GDP has been up each of the past 9 quarters. The last decline in real GDP was in the second quarter of 2009.
The economy is growing, even if at a less than optimal rate. It isn't receding. And, growth is likely to continue through 2012.
Calling this a recession because unemployment remains high or because it "certainly feels like a recession" is lousy analysis that leads to a misrepresentation of trends relevant to the stock market.
The growing U.S. economy is one reason why corporate profits have been rising, and will continue to rise in 2012. This has been a major factor in the rising stock market the past three years.
Specifically, continued economic growth will lead to further profit growth for U.S. corporations. That could well support further stock market gains.
It is simply wrong to call this a recession.
Number Two: The Argument That It Is All about Jobs
The most important objective of a successful economy is to create goods and services that are valued by society. Policies should be directed towards this goal -- not simply creating more jobs.
Not all jobs are created equal. A good job is one in which the inputs (compensation and related) cost less than the value of the output created. Yes, that means that good jobs produce a profit. Profits reflect a successful economy using resources efficiently to create goods and services worth more than they cost to create.
Government jobs, or even government subsidized jobs, do not always create a profit. That means that the resources put into the job are greater than the output. Creating these jobs is not good -- they create a drag on the overall economy.
A government job which costs more than the value it creates simply means that the government must either take more resources (taxes) from productive sectors to subsidize an unproductive job, or the government must borrow money and increase government debt.
To create jobs that cost more than the value they create will not boost the economy over the long run.
The blather from politicians that government must do whatever it takes to create jobs, or in support of any policy simply by saying it will create jobs, should not be tolerated.
It is not all about jobs. It is all about creating economic conditions that will lead to jobs that produce a profit (create value).
Number Three: Absurd Statements from Frustrated Bears Unwilling to Accept Good News from Europe
Whenever the stock market rallies on a positive development regarding the European debt crisis, there is certain to be someone on TV stating emphatically that "This won't solve the European debt crisis." The implication (from the person who is probably short the market) is that the rally is unfounded.
This is ridiculous.
Stock market valuations are being held back by concerns about the European debt crisis. In other words, a negative impact on future U.S. profits from ongoing European problems is already priced into the stock market.
When a positive development occurs in Europe, the stock market rises because the probability of any particular negative impact on profits has decreased. It is logical for the stock market to rally on positive developments in Europe.
No one expects the European debt crisis to be solved any time soon. Europe faces years of economic and financial difficulty. That doesn't mean the U.S. stock market can't go up. After all, the S&P 500 is up 37% the past three years while the European debt crisis has persisted.
If political and credit market conditions improve in Europe, that will mitigate the negative impact on U.S. corporate profits compared to what is currently priced into the market. That can lead to further stock market gains.
The suggestion that any rally based on positive developments out of Europe is unfounded has been common the past year -- just watch what happens the next time it occurs.
It won't be long before someone says, "Who can possibly believe this will solve the problems in Europe." That reflects a total lack of understanding of how markets price in possible outcomes, or simply an unwillingness to accept good news.
Good news is good news, regardless of whether it completely solves the problem.
Number Four: Excessive Criticism of the Federal Reserve
There are many who want to blame the Fed for the excessive rise in debt levels over the decades prior to 2008. There are also many who want to blame the Fed for the continuing economic problems in the U.S.
It is my opinion that these criticisms are unfounded.
There are certainly things the Fed would have done differently with perfect hindsight, but the reality is that the Fed managed credit markets reasonably well during the past few decades.
There is a long history of capitalist credit cycles that are probably impossible to manage. Credit growth tends to rise over time, and then eventually hits a wall and becomes constrained. This is more due to human behavior than monetary policy.
Current economic and credit market conditions are particularly troublesome. There is no easy solution. The Federal Reserve, in my opinion, has managed monetary policy extremely well following the 2008 collapse. Economic conditions could have been far worse.
The Federal Reserve has been working to create credit expansion, but the reality is it can't "push on a string." Demand just isn't there, and it will take time to develop momentum.
The Federal Reserve isn't omnipotent. The best it can do is to react to conditions in the private economy and private credit markets. In my opinion, the Federal Reserve has done a very good job. It is unreasonable to expect that the Federal Reserve should have managed to recreate "normal" credit market conditions and economic growth.
Number Five: The Argument That Stocks Aren't Cheap
The P/E is often used simplistically and misleadingly.
To compare any given P/E to historical levels is to ignore half the relevant analysis. It is about as intelligent as looking at bond yields without any consideration for inflation.
The P/E is nothing more than the inverse of the E/P -- the earnings yield on stocks.
The current P/E is 13. The long-term historical P/E is about 14. The simplistic analysis suggests that stocks therefore aren't cheap. Wrong.
The earnings yield (E/P) on stocks right now is about 7%. That may not be a lot more than the historical yield of about 6.5%, but current conditions are quite a bit different that long-term historical conditions.
Specifically, inflation and interest rates are well below long-term levels. That makes the current yield on stocks extremely high relative to interest rates; and when compared on this basis, stocks are extremely cheap by any historical comparison.
Now, it can be argued that stocks are cheap for good reasons and that, therefore, it would be unwise to invest in stocks.
But there should be no argument amongst thoughtful analysts that stocks are cheap. They are very cheap.
What It All Means
Current fashion is always difficult to fight. Wise investors, however, will look past the noise to sound analysis.
The pet peeves above are all related to situations in which emotions override reason.
The conventional wisdom that this is a bear market and a recession is based largely on the reality that wealth for most investors is still below 2007 levels. That is painful.
It also seems unsympathetic to argue against government actions to spur job growth. It is easy to simply blame the Fed for all our problems, and perhaps that feels good.
None of that is useful analysis for looking towards investment opportunities, however.
The data indicate that stocks are cheap, stock prices have been rising despite the ongoing European debt crisis, the economy is growing, unemployment is dropping through private sector job creation, and credit market conditions are improving.
Whether the European debt crisis undermines these trends in the year ahead is subject to legitimate debate, but I, for one, will base my analysis on the conflicting forces as they are, not as they feel -- and will probably continue to be annoyed by much of what I hear and read that passes for analysis.
