I can live with this.
In terms of profits, Siegel
believes that the fundamentals are there.
The only thing Siegel sees
that is holding back investors: “I’m increasingly believing what Federal
Reserve Chairman Ben Bernanke called…the fiscal cliff that’s coming at year
end, with $500 billion worth of taxes and spending hits. I think that’s really keeping a lid on the
market.”
In March I posted some of my
thoughts on future price behavior of the stock market and I have not changed my
mind since then. (http://seekingalpha.com/article/440181-economy-vs-markets-and-the-winner-is)
However, I think that the
European situation is also keeping retarding stock performance.
Two indicators I referred to
at that time that seem to bear some relationship to the stock market
performance are an index of financial market confidence and an index of financial
market liquidity. In early March, both
indicators were pointing toward a stronger performance of stocks. Both have weakened slightly since then…and
these movements can be explained by events in Europe.
One such confidence index is
published by Barron’s and is the ratio of the yield on Barron’s Best Grade
bonds and the yield on Barron’s Intermediate Grade bonds. A sign of confidence in the financial market
occurs when this ratio goes up because investors are not requiring as big a
premium in yields between these two grades of securities as were required
before. This is usually a good sign that investors
are willing to commit to the financial markets.
This
calculation can be duplicated using information provided on the H-15 release of
the Federal Reserve where the ratio of yield on Aaa-rated bonds to the yield on
Baa-rated bonds can be calculated.
In the
March post I wrote “Last year this confidence index reached a near term peak in
June and declined throughout the summer and fall until February of this year.
It has since risen into the middle of March.
The earlier period coincided with a lot of uncertainty in the US economy
and with the rising concern about the European sovereign debt situation. The
pick-up in confidence came about as economic information seemed to improve and
as the situation in the eurozone with respect to Greece improved.”
The
Confidence Index hit a near term peak in late March as concern over the
European situation rose in world financial markets. This index still remains near recent highs.
The
Liquidity Index measures how yield on US government debt compares with the
yield on high-grade corporate debt. Here
one can go to the Federal Reserve release and calculate the ratio between the
yield on 10-year US government issues and the yield on Aaa-rated corporate
issues. The higher this ratio, that is,
the closer the Aaa-rated issues are trading relative to the government bond
yield the more liquid the financial markets because money is flowing almost as
easily into the corporate sector as it is into the most liquid market in the
world, the market for US Treasury issues.
In March I
wrote, “The liquidity index dropped through much of 2011 and
bottomed out in December. This index has been rising since then into the middle
of March. The decline occurred because so much money went into Treasury issues
from other issues in the financial markets, a “move to quality”. Over the past
few months we have seen a reversal in this as funds have flowed back into these
other issues making the market, as a whole, more liquid.”
Well, guess what?
With the recent buildup in concern over the financial situation in Europe,
the “flight to quality” picked up again and vast amounts of money flowed into
the US Treasury market. This “flight to
quality” also impacted the yield of German government debt. The movement had little impact on other financial
market yields.
In the middle of March 2012, the yield on the 10-year US
Treasury bond was in the 2.25% to 2.40% range.
Now, the 10-year is trading in the 2.00% range.
In the middle of March 2012, the yield on the 10-year German
bond was in 2.00% to 2.10% range.
Currently, this bond is trading in the 1.70% to 1.80% range.
This “flight to quality” has impacted the Liquidity Index
and produced a moderate drop in the relationship between government securities
and high-grade corporate securities.
There is a correlation between each of these measures and
the money flowing into the stock market.
Right now, the Confidence Index seems to be holding its own, given the
flows of funds in the financial markets, but the Liquidity Index has
weakened.
Given past experience, I do not expect to see the stock
market to move ahead to substantially higher levels until we see some further
resolution of the financial situation in Europe. As long as the financial markets are focusing
on “quality” and there is a remnant of the “flight to quality” remaining, stock
market performance will remain relatively modest.
So, I am agreement with Siegel on the future trajectory of
the Dow Jones Industrial Average. I
believe that the Dow Jones will reach 15,000 by the end of 2013. I believe that the economic situation can
support such a rise. (See my post from March 30: http://seekingalpha.com/article/469671-gdp-growth-the-road-ahead-and-the-investment-climate.)
I agree with Professor Siegel that we have a fiscal problem
in the United States that must be dealt with in some manner by the end of this
year and that this is a concern of investors.
However, I also believe that the European situation is
impacting US stock performance and this will tend to hold back the rise of
stocks until the European Union reaches a more complete solution.
In general, therefore, I am looking forward to a strong
movement in the stock market over the next 12 to 18 months.
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