Monday, December 13, 2010

Sugar and Spice: Bullish on US equities/Worried about Bonds

To the chagrin of Mrs. Random Glenings - who notes that we have a considerable amount of holiday preparation still to be done - I spent a lot of time this weekend reading about the new tax compromise package that has been reached in Washington.

I'm not sure who comes out the political "winner" in all of this - initially it looked liked the President caved in to the other party, but other observers have suggested that the compromise is really a stealth stimulus package, which is what the President favored all along.

What seems clear to me, however, is that we should see at least a nearer term economic boost in the first half of 2011, and the equity markets should be the beneficiary.

One of the articles I read was from the London Telegraph. The author is based in the U.K., but he believes that the U.S. markets might actually be one of the best performers in the next year:

The rebound in {corporate} margins means that the average earnings for the constituents of the S&P 500 should be higher than at the previous peak in 2007 and around one-and-a-half times higher than in 2000, when the US stock market hit a peak of 1,527, 24pc higher than today's level.

Although valuations were then clearly excessive, the combination of a much lower market and much higher earnings means shares are much better value today. With earnings expected to grow at a double-digit rate both next year and the year after, the multiple of earnings investors will be prepared to pay could also rise. It is that combination of higher earnings and a rising price to earnings ratio that always characterises the best years in the market.

The final reason why 2011 could be America's year is the sheer weight of money that is sitting on the edge of the equity market. I think the rise in yields on government bonds in the past few weeks might mark a watershed moment when investors start to question whether they have got their money in the right place.

Why US equities could be hard to beat in 2011 - Telegraph

All of this being said, I should also note that there seems to be considerable alarm in Europe and elsewhere about the apparent inability of the U.S. government to address our fiscal deficit.

Several articles suggested that the recent rise in interest rates has not been due to any concern about inflation. Instead, these observers suggest that there is a growing unease with U.S. policies in general, and that perhaps the world's creditor nations - China and Japan, in particular - will be demanding a greater "risk premium" for U.S. debt.

Here's a fairly typical piece from the BBC in England:

The competing explanation may appear to be based on an almost diametrically opposite view of the prospects for the US. It is that the tax cut shows a US administration utterly incapable of getting to grips with public-sector deficit and debt as unsustainably large as anything the fringe of the eurozone can boast - which proves that the quality of US sovereign debt ain't what it was, so you sell.

On this interpretation, the US economic recovery won't accelerate enough to generate a sufficiently big increase in tax revenues, to make a sizeable dent in an annual deficit running at around $1.5 trillion or well over 10% of GDP...

But the big question is whether what's happening to US treasury bonds shows that those who control the vast pools of money are becoming more or less confident about the outlook for the biggest economy in the world and for growth prospects in general.