Stocks are "under-owned," underappreciated and maybe even undervalued.
We’re almost halfway through 2013 and stocks, as measured by the S&P 500 Index, are up approximately 18% in terms of total return. And the latest economic data—retail sales and inflation expectations—are pointing toward better days ahead. But despite this economic progress, a six-month rally on Wall Street, a healthier housing market and the Fed’s endless stream of easy money, investors remain largely unconvinced.
The April Index of Leading Economic Indicators rose 0.6%, with housing permits, the interest rate spread and labor-market conditions all chipping in. However, consumer expectations, one of the key components of the index, were down. This is surprising because the preliminary reading of the Thomson-Reuters/University of Michigan consumer sentiment index rose more than expected while retail sales for April, also reported last week, came in higher than expected. Higher retail sales suggest that the burden of the payroll tax—which now takes 6.2% of employee paychecks—is being more than offset by an improving consumer balance sheet.
The good news for people’s pocketbooks? Consumers are taking on debt at a slower pace—just $8 billion in March versus expectations of $15 billion—and a majority of it is non-revolving debt rather than revolving debt. Non-revolving debt is typically used for big-ticket items such as cars and college education and usually carries a lower interest rate. Revolving debt, on the other hand, is primarily from credit cards, which carry higher interest rates. Consumers are benefiting not just from less overall debt but also lower interest rates for the servicing of that debt. The proof can be found in the household debt service ratio—the amount of income required to cover debt costs—which is at an all-time low of 10.4%.
Meanwhile, consumers may also be exhibiting signs of the “wealth effect” created by higher prices in both housing and stocks. With markets prospering and home values appreciating, people tend to feel more financially secure.
No Bubble in Stocks
Of course, propelling both housing and stocks higher has been the Fed’s easy-money policies. But it seems many investors remain skeptical that stocks make attractive investments. A recent Gallup poll of US adults shows that stock ownership is at its lowest level since 1998. And ownership has not increased from a year ago despite the stock market’s huge rally. Only 52% of Americans surveyed said they own stocks directly or through a mutual fund or a self-directed retirement account. By comparison, in April 2001, as the tech bubble was deflating, 62% of Americans owned stocks. Similar results can be found in a recent poll by the American Association of Individual Investors, which shows that as of May 16, 38.49% of individual investors it surveyed are bullish on stocks versus 63.5% who were bullish as of May 3, 2001.
Intuitively, it seems many investors are wary of stocks because of the dramatic run-up they’ve experienced. Their anxiety is reflected in the fact that the most defensive sectors have outperformed so far this year. Many investors assume that stocks are expensive right now because of all the records they’ve set this year. However, a look at valuations relative to previous historical records suggest today’s valuations are far more tempered. Consider that:
- In April 2000, when the S&P 500 hit a record high, trailing P/E was at 27.4 and forward P/E was at 25.6.
- In October 2007, when the S&P 500 hit a record high, trailing P/E was at 16.5 and forward P/E was at 15.2.
- Last week, when the S&P 500 hit another record high, trailing P/E was at 14.7 while forward P/E was at 14.3.
Perhaps the best news for stocks is that the fuel that has propelled them—the Fed’s incredibly generous monetary policy—seems unlikely to be ending soon. Although bond yields backed up last week, perhaps pricing in a possible tapering of quantitative easing. That’s because inflation has remained tame. In fact, the April consumer price index fell 0.4% thanks to a drop in food and energy prices. And core CPI, which excludes the volatile food and energy components, gained just 0.1%. The Fed is looking to keep interest rates artificially low until unemployment falls below 6.5%—as long as inflation remains in check. April’s CPI reading provides a good indication that inflation isn’t poised to jump higher, at least for now.
Investors are clearly cautious about the stock market. But given improving economic conditions and the loose money policies that are likely to last for several years, equities look attractive. Americans’ low stock ownership should be a wake-up call: in an era of financial repression, investors should consider exposure to this important asset class.
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