US Bull Headed For A Painful End
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“What the heck happened to the stockmarket?” asks CNBC.com. Last week, US stocks tanked, with the S&P 500 and the Dow Jones indices falling by almost 3% to three-month lows. The tumble engulfed the FTSE 100, which notched up its biggest weekly fall since July 2003.
Chalk it up to an inflation scare: Richard Fisher of the Federal Reserve Committee warned that inflation was near the high end of the Fed’s tolerance level. It seems investors have finally concluded that “inflation is going to be a bigger problem” than they, or the Fed, have hitherto been willing to admit, says The Wall Street Journal.
So the Fed is now likely to raise interest rates further than previously expected, while the outlook for economic growth is already clouding over. One worry is that higher energy prices may crimp consumption, which accounts for 70% of the economy. As David Stires points out in Fortune, households are due to spend 27% more on energy this year than in 2003, which bodes ill for discretionary spending. Oil-price spikes take a year to filter through the system, so the impact of the latest one won’t be felt until 2006.
And don’t forget the housing bubble, says Bill Fleckenstein on MSNMoney.com. Soaring house prices have underpinned consumption by encouraging borrowing against the value of homes, but this “housing ATM” appears to be on its last legs. Ominously, even in the hitherto “hot” New York market, the number of properties for sale, and length of time on the market before being sold, has risen.
Given the cloudy outlook, the recent upward revision in fourth-quarter earnings – these are expected to expand by 14%, and by a figure in the high single-digits next year – may prove over-optimistic. David Rosenberg of Merrill Lynch has taken his earnings growth forecast for 2006 down to just 2% and warns that “equity valuations are not priced for such an outcome”.
Indeed – the S&P’s trailing p/e of 19 is still 25% above its long-term average, which, given that valuations gradually revert to the mean after a bubble, is another reason for caution. This bull run is getting long in the tooth and entering its final phase, says market historian Ned Davis.
And the run has been driven primarily by earnings growth, rather than expanding p/e ratios, as most upswings are, says Henry McVey of Morgan Stanley. Worryingly, the aftermath of earnings-driven bulls has historically been “particularly painful”, with an average fall of 12% in the S&P during the year after the rally ends
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