The lead article in the April 2013 issue of Bank Watch is “Process of Elimination Becomes the Catalyst,” authored by Jeff Davis, managing director, and originally published on SNL Financial (republished with permission). The article begins …
An old market saw is that bull markets take the stairs and bear markets take the elevator. The current market fits the bull market description given the slow grind higher. The S&P 500 has produced a total return of 9% YTD, 15% since the post-election low on November 14 and 43% since October 4, 2011, when equities and credit cratered following the downgrade of the U.S. and seizure in the funding markets for European banks.
The recent gains are impressive given the lack of any meaningful pullbacks other than two brief periods of less than 10% since the Q3’11 swoon. Otherwise, the S&P 500, Russell 2000and NASDAQ Composite charts are a series of higher highs and higher lows. The recent run is curious because of the weekly announcements of weak and/or an unusually uncertain operating environment (I recognize the future, by definition, is uncertain) that retail-oriented companies are
making. Markets have an uncanny ability to see 6-to-9 months out. So, recent strength may point toan improving economic backdrop by the fall.
Or maybe the Fed’s elixir is lasting longer than expected when the current round of QE was announced last fall. Chairman Ben Bernanke has been very explicit that the Fed is targeting equity (and real estate) markets to support the economy via the presumed wealth effect. I would add the targeting of real estate markets has supported the recapitalization of the banking sector — a project that is now complete if one disregards a subset of troubled small banks. The strength of equities
probably will not elicit any commentary in next week’s Federal Open Market Committee meeting, though Bernanke may be asked about equities during the press conference that is scheduled to follow the meeting.
At Mercer Capital, we have spent 30 years studying equity market returns, expectations and how various components in a capitalization rate (or capitalization factor) alter value. There is no need to go into the theoretical underpinnings of discount rates and capitalization rates in this setting, but if you are interested see: Valuing Financial Institutions (by Chris Mercer; 1991) and Morningstar’s Ibbotson SBBI Valuation Yearbook. Aside from the large- and small-cap equity risk premium, the level of long-term “risk-free” rates (here measured by the 20-year U.S. Treasury) and expected long-term earnings/cash flow growth are key. The level of Treasury yields and earnings multiples are inversely correlated, while expected (sustainable) earnings growth and multiples are positively
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