Economic Insights - August 2017

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The U.S. economy and stock market has come a long way since the last financial crisis. And contrary to the view of many, we’ve got a long way to go before the next crisis.  Consider the facts.

In March 2009, the stock market started its current bull run.  At first, it was a V-shaped bounce from the panic lows, starting after mark-to-market accounting was eliminated.

Next, as the economy slowly recovered, earnings drove stocks higher.  But then, between May 19, 2015 and November 3, 2016, the Dow Jones Industrials Average fell 2 percent, while other indices stagnated.  The combination of a sharp drop in earnings due to lower oil prices coupled with election uncertainty caused a great deal of anxiety.

But since then, the Dow is has generated a total return of nearly 22 percent and the tech-heavy NASDAQ returned 25 percent.  These gains have happened as rising expectations about government policy led to good stock market outcomes.

Last December we set our year-end 2017 stock market targets at 23,750 for the Dow and 2,700 for the S&P 500.

At the time, these targets seemed wildly bullish to many investors.  But today, we need barely more than an 9 percent increase to hit those targets.  If the we actually get better tax, spending and regulatory policy in 2017, those targets are probably too low!

Our forecasted is based on a Capitalized Profits Model.  It uses the U. S. government’s measure of profits from the GDP reports divided by interest rates to determine the fair value for stocks.  Using a current 10-year Treasury yield of about 2.3 percent says the S&P 500 is massively undervalued.  That number is meaningless because the Fed is holding interest rates artificially low.

Using a more rational 10-year yield of 3.5 percent, fair value for the S&P 500 is 2,700, which is our target.  The model needs a 10-year yield of 3.82 percent to conclude the S&P 500 is already at fair value, with current profits.

The Federal Reserve made no changes to interest rates in July and made almost no changes to the text of its statement.  In our view, the Fed will announce the start of balance sheet reductions at the end of its next meeting on September 20th.

While others fret about renormalization and...

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