Point, counterpoint

A few posts ago I laid out my view of the market arguing that the general risk/reward trade-off in the stock market had shifted to the point in which the prospect of additional upside was outweighed by the prevailing risks on the horizon over the next few months. Indeed, the wide swings in sentiment through late summer underscored the uncertainty. Stocks did pullback, with the S&P falling to 1630 in late August. However, some of the grinding issues that were hanging over the market have since been at least watered down to some degree. Yellen looks certain to be the next Fed chief, Germany overwhelmingly re-elected Merkel, and interest rates have retreated from their recent highs. Meanwhile, the market has clawed back its losses to remain essentially flat, hovering right around the 1700 level. Sentiment still remains mixed but the wide divergences we saw a month ago seems to have abated somewhat. I am admittedly surprised by how quickly we recouped those losses and while I still maintain that, at this stage, the risks outweigh the potential for further gains over the next few months, the market’s recent resilience should not be discounted.

Since that post, I had the pleasure of attending a speech by Jim Paulsen from Wells Capital Management in which he decreed a markedly more upbeat view of the market and the economy. Since I first began following him in 2010, Paulsen has been a staunch bull throughout all of the obstacles we have overcome. I’ve come to respect his views and his ability to maintain a long-term outlook in spite of all the noise present in the markets over the last 3 years so I thought it worth sharing his perspective here. Below is my summary of his outlook.

• Although the current recovery is slow, it is not significantly different (in terms of a rebound in GDP growth) than other recoveries since the mid-80’s when growth in the working age population began to slow
• Since then, unemployment and consumer confidence have peaked and bottomed respectively, well after the official end of recessions (granted, we’ve only had 3)
• For the first time in a long time, housing and manufacturing are both rising while overall corporate profits are already 25% above their previous peak
• The ongoing energy boom is providing unexpected “dividends” and inflation looks set to remain subdued
• Growth in the private economy has consistently been stronger than the comprehensive headline numbers suggest and consumer confidence is at its highs…
• Meanwhile, fiscal policy has been a significant drag, taking roughly 3 percentage points off of GDP in the last 12-18 months.
• What he describes as Real Pent-up demand, which includes both the public and private sectors, has been consolidating since 2000 and looks poised to break out to new highs.
• The common thread that brings all of this together is rising confidence which, given the pent up demand in the economy, is close to propelling the economy into sustainable growth mode… and interestingly, he sees tapering as inconsequential to this thesis.

I admit he makes a compelling argument (trust me, it’s even more so in person!). And he is certainly coming at it from a different perspective than most market prognosticators. However, this year’s gains have come almost exclusively on the back of multiple expansion. That leaves me to wonder if these points haven’t already been priced in. Shouldn’t we be concerned about labor force participation being at all-time lows and the absence of top line growth from Corporate America? In my opinion, there is still a strong argument that stocks are fully valued today, having already discounted this growth potential. At some point, the economy needs to justify these market levels before we can move to the next stage of discounting future growth.