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VOL. 37 | NO. 44 | Friday, November 01, 2013
Markets continued their record march this week as a tepid jobs report reinforced expectations for further Fed stimulus.
In anticipation of “print it” Janet’s reign, the 10-year Treasury yield has frozen at 2.5 percent. With a valuation of 17x trailing operating earnings, S&P 500 earnings yield nearly 6 percent. Obviously 6 percent is more than 2.5 percent, making stocks more attractive than bonds. To wit, equity mutual funds have added $32 billion in assets since May 31, while bond mutual funds have shed $128 billion.
The longer interest rate expectations remain anchored at low levels, the more enticing the gap between the earnings yield for stocks and the interest rate yields for bonds. This explains the continued push into record territory for the stock market. As rate increase fears abate, stocks escalate.
Wanted: Better Fundamentals
There are 212 S&P 500 companies that have now reported third quarter earnings. Overall, 68 percent of earnings reports have exceeded analyst expectations. That’s good. However, only 42 percent have beaten revenue expectations. That’s bad. When you compare the third quarter growth figures with the second quarter, revenues and earnings appear stagnant. Looking forward the street’s fourth quarter estimates look high when matched against the pessimistic guidance companies have issued. Why are things so sluggish?
Needed: Corporate Investment
Record corporate profits and profit margins should inspire enthusiastic capital investment spending (factories, machines, software, etc.). Interest rates have fallen, wage rates have fallen and energy costs have fallen, freeing capital to be put to better uses. These uses must be hard to find. U.S. corporations are sitting on $1.5 trillion of sidelined cash and liquid securities. Due to our goofy corporate tax system, $900 billion of this total idles overseas.
Economies thrive on capital investments, which generate innovation, productivity gains, and national competitiveness. Since the great recession, our nation’s 2 percent growth rate places our pace well below potential. Corporations seem uninspired to fortify our economic foundation. Credit has been hard to get, taxes have been hard to pay and regulations have been hard to comply with. Uncertainty about the sustainability of the recovery, and the future demand for goods and services also adds ankle weights. Corporations need a pep talk. Corporate tax simplification and reform would go a long way to stoking investment enthusiasm. Unfortunately, the light from Obamacare blinds us to all other legislative initiatives, including corporate tax reform. If the goal is more job creation, we need more corporate optimism and more capital investment. Without it, we will continue to suppress the speed of this recovery and become even more dependent on the Federal Reserve to paper over our problems.
The last time we had real tax reform occurred in 1986. We greatly simplified the code and lowered the top marginal rate from 50 percent to 28 percent. The economy grew at a 4 percent annualized rate for the remainder of the decade and government tax receipts INCREASED as a percentage of GDP from 17.5 percent to 18.5 percent. By lowering rates and simplifying the code, both citizens and government made more money. Maybe we should do that again!
David Waddell, who is regularly featured in the Wall Street Journal, USA Today and Forbes, as well as on Fox Business News and CNBC, is president and CEO of Memphis-based Waddell & Associates.