Is the record-setting bull market going to end this year, catching investors flat-footed? Lots of analysts and investors have already been surprised by how long the bull market has lasted, and they worry that stocks—recently at historic highs—are vulnerable to a replay of the 2000 and 2008 collapses.
But top economist and regular Bottom Line/Personal contributor Allen Sinai, PhD, is not one of those worriers—in fact, he thinks that this equity bull market, with occasional interruptions, is likely to continue through at least the first half of 2015.
Here is what Sinai forecasts for the rest of this year and beyond…
WHY THE BULLS HAVE WON
I appreciate the skepticism that nervous investors are feeling right now—especially after four years of a robust bull market. But when I look at where we are historically in the business and financial cycle, it suggests to me that there is a long way to go in the economic expansion and equity bull market. Here’s why…
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- Reasonable stock valuations and decent corporate earnings. At peak levels in previous bull markets, the price-to-earnings ratio (P/E) of the S&P 500 stock index (a good proxy for the overall status of stocks) has been 19.9 based on the previous 12 months’ earnings. It is now much lower, just 15, which is fairly normal by historical standards. Moreover, I think the US and global economy are improving enough to produce healthy US corporate earnings growth—in the 7%-to-8% annual range—over the next few years.
- The “slow-motion” recovery. Today’s tepid growth in the economy isn’t entirely negative. The way I see it, the economy has been mending quickly enough to calm fears of a recession but slowly enough to convince the Federal Reserve to keep interest rates low and cash for lending plentiful.
To be clear, today’s unemployment rate of about 7.5% is distressingly high and represents real hardship for out-of-work Americans. But the job picture is brightening. Compared with the same time last year, the unemployment rate is more than half of one percentage point lower now.
- The Federal Reserve’s generosity. As long as inflation remains mild—it was 1.1% year-over-year in April 2013—short-term interest rates will remain near zero and long-term rates will be held down through the government’s big monthly purchases of Treasuries and mortgage-backed securities. Low borrowing costs encourage companies to invest and expand.
- The US government’s improving fiscal outlook. Figures from the nonpartisan Congressional Budget Office indicate that US finances are healing. Tax revenue is up…government spending is down…and the budget deficit is projected to shrink to 4% of gross domestic product (GDP) this year, less than half its 2009 level, and to 2.1% by 2015.
All these elements working in concert remind me of the 1990s, when stocks enjoyed a nearly decade-long rise supported by easy-money policies from the Federal Reserve and (for most of the decade) a steadily growing economy.
DANGERS STILL EXIST
Of course, the 1990s ended catastrophically for the stock market with a burst bubble in 2000–2001. I don’t think that is likely to happen in the current environment unless the Federal Reserve errs badly in tightening monetary policy.
I expect that as the year progresses, unemployment will fall low enough to convince the Fed to start tapering down its monthly asset purchases, allowing long-term interest rates to start rising…but even then, the Fed will remain accommodative, waiting until late 2014, when inflation is higher, to begin signaling a hike in short-term interest rates. On June 19, Fed Chairman Ben Bernanke said the Fed’s massive bond-buying program may be scaled back starting late this year and possibly ended by mid-2014. The remarks set off a two-day plunge of nearly 4% in the Dow Jones Industrial Average.
A word of caution: If inflation spikes and the Fed has to raise interest rates more aggressively and sell Treasury securities—and at the same time corporate earnings dive—investors should be prepared to reduce their allocations to stocks because the market could drop precipitously or move sideways for an extended period.
KEY ECONOMIC MEASURES
Here is what I expect for the rest of this year and next year…
GDP: The US economy trudged along in the first quarter of 2013, growing at a 2.4% annualized rate. But for all the reasons I’ve given above, I expect growth of 2.7% for 2013 as a whole and 3% in 2014, compared with 2.2% in 2012 and 1.7% in 2011.
Unemployment: The official figure fell from 7.9% in January 2013 to 7.5% for April. I’m predicting an average gain of about 175,000 jobs per month for the rest of this year, which would push the unemployment rate down to 6.9% by the end of 2013.
Inflation: As measured by the Consumer Price Index (including food and energy), I expect inflation to rise slightly in response to the improving economy by year-end, but only to 1.5% for 2013, compared with 2.1% in 2012.
OUTLOOK FOR STOCKS
I’m forecasting that the Dow Jones Industrial Average will rise to 16,200 by the end of 2013, up 24% for the year. The S&P 500 should hit 1,725, a 21% increase. Investors will need to endure periods of volatility when the broad stock market gets overbought and retreats by as much as 10%, but I would view such dips as buying opportunities.
Recommended: Housing and consumer discretionary stocks such as automotive companies, Internet retail, leisure and hospitality…financial stocks, which will see stronger earnings growth, thanks to investor interest in the stock market, more IPOs and increased bank lending…and Japanese stocks. The Nikkei Index, at around 14,000, gained about 33% this year through May (despite a sharp pullback in late May), and I expect a multiyear rally as the Japanese government and the Bank of Japan continue to take dramatic steps and jump-start a solid economic recovery.
OUTLOOK FOR BONDS
As has been the case for some time, both US government and corporate bonds carry great risk of losing value as interest rates rise to more normal levels. To avoid substantial losses, most bond investors should shorten the maturities of their bond holdings to five years or less.
OUTLOOK FOR GOLD
Gold has been a big winner for investors in recent years. Now, with less fear in the markets in general, the price of gold has plunged 23% (through June 20) to about $1,300 per ounce. For the foreseeable future, I expect to see gold in a trading range between $1,000 and $1,500, and though I don’t expect the price to crater from here, I have turned neutral-to-bearish on gold for the first time since it sold for $350 per ounce 11 years ago.