Arrogance Kills Bull Markets But This One Remains Humble

Companies need to increase the pace of hiring to keep this bull market going, right? They need to shell out more in capital expenditures, right? Oh and don’t forget inventories, they need to boost them big time. Right??!

Not so fast, says Adam Parker, chief U.S. equity strategist at Morgan Stanley. While all that may be good for economic growth, if overdone it also could threaten profit margins and hasten the end of the cycle that’s almost tripled the Standard & Poor’s 500 Index in the past five-and-a-half years.

“Management arrogance gone awry,” is how he described it to Trish Regan on Bloomberg Television’s “Street Smart” program yesterday. “Too much hiring, too much inventory, too much capital spending. As long as they don’t do that, the probability of the cycle ending isn’t really there and you can kind of have a slow and steady cycle that lasts a long time.”

“Hubris and debt” mark the top of every cycle, Parker and colleagues wrote in a report yesterday, and these days it’s hard to make the case that the peak is near. U.S. companies are showing discipline when it comes to hiring, capital spending should remain muted and inventories relative to sales are growing at a rate that shouldn’t be a big problem for margins, they wrote.

As far as debt goes, companies are earning enough money to cover interest expenses much more easily than in the past, with the coverage ratio for the biggest 1,500 companies doubling in the past five years, according to Morgan Stanley’s math.

Bullish Turn

The recent dip in stocks, which sent the S&P 500 down as much as 3.9 percent from its last record close on July 24, made Parker and his colleagues bullish again.

They especially like technology companies and upgraded the industry to overweight, the equivalent of buy, from market-weight, or hold. Consumer discretionary stocks, the worst-performing group this year among the 10 main industries in the S&P 500, also caught their interest. The strategists added payment-processing company Vantiv Inc., Nike Inc. and Las Vegas Sands Corp. to their model portfolio.

“The way that portfolio managers should address the question of how to get more bullish is to buy health-care, technology, and consumer discretionary, and to sell consumer staples and financials,” they wrote.

Parker expects the S&P 500 to reach 2,050 by the middle of next year. That would be a 5.8 percent rise from yesterday’s close. For the record, Parker is no Pollyanna when it comes to his projections. The S&P 500 finished 2012 and 2013 more than 20 percent above his forecasts in January of those years, while in 2011 he came within 2 percent of the mark, according to data compiled by Bloomberg.

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