Maintain Bullish Policy
By Arnie Kaufman
High liquidity and improved prospects for the economy are the key positives for the market. Corporate and consumer spending is bound to be spurred by the huge amount of reserves injected into the system by the Fed over the past year, as well as by ongoing tax reduction. Increased federal outlays for defense, security and reconstruction will provide further stimulus.
Price-earnings ratios on the S&P 500 index are higher than they were at the same stage of earlier cycles, but this should not be a major concern. Actual and estimated earnings on which the p-e ratios are based will be rising as the economy pulls out of recession. A big kick will come late this year or early in 2003 when large-cap technology companies (heavily influencing S&P 500 earnings) start to benefit from stepped-up capital spending.
Also, p-e ratios tend to be high when the general level of interest rates is low. That's because demand for stocks increases when returns are meager on fixed-income investments competing with equities, as is the case now. S&P chief economist David Wyss expects the current recession to be one of the mildest on record and likely to end within a year of its March 2001 starting point. If it runs a full 12 months, it will mean that since November 1982, there were two expansions lasting a total of 212 months and two recessions lasting a total of 20 months, or an expansion-to-recession longevity ratio of 10.6 to 1. Going back to 1900, that ratio had never before been higher than 6.2 to 1 and has averaged just 3 to 1. The more than 10 expansion months for each recession month in the past 19 years or so presumably reflect more astute Federal Reserve monetary policy and computer-aided inventory control. This economic strength and dependability contributes to high stock valuations.
Investors have been badly shaken by the bear market and terrorist attacks, and will move carefully. But the upward trend seen since the September 21 low should continue.
Kaufman is editor of Standard & Poor's weekly investing newsletter, The Outlook