Despite a lackluster economy, an uncertain political
environment, and the potential for ample downside, U.S. equity
markets and the iShares S&P 500 [[SPY]] continue to post solid,
positive returns. Considering its unprecedented amount of monetary
support, the Federal Reserve has had a weak effect on unemployment
levels and aggregate demand. However, it has been undeniably
successful at creating a "heads I win, tails you lose" mentality
for investors. If the economic recovery falters, it is perceived
that the Fed will ride to the rescue (with the implication of
success). If, on the other hand, the economic recovery continues
apace, it is believed the market's ascent should too.
Economic data for the month of July remained mixed. Employment
figures are a good example of the variation across reported
figures. The establishment survey showed that the private sector
added 172,000 positions in the month of July, while the household
survey had employment declining 195,000 jobs and the unemployment
rate rising to 8.3%. Hours worked and weekly earnings rose in the
month, but so too did unemployment claims, which have bounced off
their lowest level in four years in the first week of July.
Manufacturing surveys, including the ISM report, signaled
contraction in the sector for the second straight month. Industrial
production, reported by the Fed, grew. Earnings growth has slowed
to a crawl, expected to rise just 3.1% year-over-year to September
2012. Earnings growth would have to reaccelerate to nearly 13.0% to
reach analysts' lofty 2013 projections--the basis of most "cheap"
market valuation claims.
At 1,413.49, the S&P 500 is trading near four-year highs and
15.9x trailing profits, earnings that are the largest ever and flow
from near-record profit margins. While many say the stock market is
cheap, we beg to differ. On more normalized metrics, the market is
expensive and its valuation rivals prior market peaks, excluding
both the technology and the housing bubbles.
Politically, the landscape is just as disjointed. Congress seems
too inept and too partisan to serve its purposes and the people.
Each day we get a little closer to the fiscal cliff of 2013 and the
tax increases and automatic spending cuts associated with it. A
significant downturn is to be expected if Congress fails to act.
Overseas, there is no additional clarity for investors.
China's economy, the supposed steam engine of world growth, has
been cooling rapidly and thus far those in command of its economy
have failed to announce any simulative measures. Europe remains a
mess, though markets there, including the iShares EAFE Index
[[EFA]], have been buoyed recently by a couple of sentences uttered
by the ECB's president, Mario Draghi: "Within our mandate, the ECB
is ready to do whatever it takes to preserve the euro. And believe
me, it will be enough."
Time will tell if the ECB will really do whatever it takes to
protect the eurozone from collapse. It is obviously in the best
interests of the world that they take action and not just mere
short-term appeasement, but something big. Though the political
environment there is much more complicated than in the states.
At this time, we expect the Federal Reserve to release
additional monetary support at the sign of economic deterioration,
Congress to delay most of the forthcoming tightening measures for
one more year, and the U.S. economy to continue to grow at a
disappointingly slow pace. This environment should suit our
high-quality, undervalued approach well.
I am long [[EFA]]. I wrote this article myself, and it expresses my
own opinions. I am not receiving compensation for it (other than
from Seeking Alpha). I have no business relationship with any
company whose stock is mentioned in this article.
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