Back on October 12 last year, I said go all in. It was time to buy.
You can see this outlook here.
Since then, the S&P 500 is up 25% and Nasdaq is up 34%.
So, that was a pretty good call. But what’s my take now as the market hits some downside volatility?
Buy weakness.
Here are six reasons why I think it makes sense to buy weakness.
Reason #1: The bulls have history on their side
The 20% gain off the bear market low is auspicious. Bank of America research shows that 92% of the time after this happens, the stock market rises in the next year. The average gain is 9%. This offers no guarantee, but if I am overweight stocks as I am now, I’d rather have history on my side than not.
Reason #2: There will be no recession
Bears keep pushing back their recession timing. But they are not giving up. Their latest rallying cry is that consumers will soon run out of excess savings. So, they will slow down spending, killing growth.
This is not going to happen. Consumers have plenty of spending power. Baby Boomers have $74.8 trillion in net worth and they are spending it, points out Ed Yardeni of Yardeni Research. Total net worth is $140.6 trillion for all households.
Next, employment remains strong, and it is not letting up. This supports income. “The U.S. economy remains admirably resilient, and odds of a recession beginning this year are receding,” says Moody’s Analytics economist Mark Zandi. “The economy’s resilience is clearest in the job market. Job growth is steadfast at near 250,000 per month. It is difficult to envisage a recession without significant job losses.”
Beyond that, consumers have a record $7.6 trillion in annual unearned income from sources like interest, dividends, rents and social security. Consumer loan delinquencies are low, and debt-servicing costs are contained relative to income.
Market internals also predict no recession. Since the October lows, cyclical groups (that do better in times of growth) like tech, consumer discretionary, materials and industrials have done well. They have outperformed defensive areas like consumer non-discretionary and utilities. The stock market is one of the best economic forecasters around.
Reason #3: The market is not expensive
Current valuations are not “low,” but they rarely are during profits recessions. The reason is that we are several quarters into an earnings recession, and p/e ratios increase when earnings decline, notes Bank of America. The current 21 p/e on the S&P 500 looks high, but multiples were higher during the Great Financial Crisis (28) and the Covid recession sell off (23). Over the past 50 years, the average multiple on trough earnings has been 20. Valuation is never a catalyst, but it has good predictive power. Today’s 21 multiple on the S&P 500 suggests 5.4% annual returns over the next decade based on history.
Also consider that if you take out the “Nifty 50,” or the S&P 500’s 50 biggest stocks which includes the big performers like NVDIA (NVDA), Meta (META), Microsoft (MSFT), Tesla (TSLA) and Apple (APPL) the S&P 500 trades at a p/e of just 15. That is a standard deviation below the historical average multiple of 18.
Reason #4: Inflation will keep falling
We’ve won the war on goods inflation. It was just 0.6% year over year in May, the lowest since November 2021, and well below the 14.2% peak in March 2022. The problem is services inflation, and that remains elevated largely because of rent increases. Rent accounts for 43% of core CPI.
However, the impact from rents will be changing soon. The official inflation gauge here tracks the trailing twelve-month rent trends. Leading indicators – the most recent leases — tell us the impact of rent on inflation will be coming down. Inflation in new leases is running around 1.7% to 4.8%.
As a result, overall inflation could be down to 3%-4% by this fall, predicts Yardeni. Keep in mind that historically after big inflation spikes, inflation comes down about as fast as it goes up.
Reason #5: Productivity boom ahead
Few people talk about productivity. But it is a key factor in the economy. A productivity boom is about to play out which will fight inflation and support economic growth.
First, a quick primer. Labor productivity is output per hours worked. Productivity growth happens when output increases more than hours worked. It’s natural to think this happens because people work harder. But that has little to do with it.
Instead, productivity goes up when companies invest more in technology and equipment that make it easier for workers to produce more. That investment is happening now in a big way, which is how we know productivity is about to rise by a lot. This will make all the difference for growth, earnings and stocks.
I believe there are four main reasons why a productivity boom is on the way. First, AI will drive it. Next, there is strong new business formation. Younger companies typically have higher productivity growth. So, the recent surge in new business formation should contribute to better productivity growth over the coming years. Third, there is wage inflation. Wage inflation typically makes companies spend more on tech and new equipment to boost efficiency. Historically, productivity has increased two years after wage inflation.
Next, a real capital spending or “capex” cycle is here. U.S. capex spending was up 14% year over year in the first quarter, following 18% gains in the prior quarter. Companies have announced $600 billion in large projects since the start of 2021, triple the normal amount, notes Bank of America. This follows ten years of underinvestment. The upshot: Technology and equipment are old, so the burst in spending is going to have a big impact.
Besides the pressure to offset wage growth, companies are spending more to “re-shore” manufacturing because of the recent supply chain debacles, and the growing geopolitical tensions with China. U.S. companies are also motivated by incentives to build domestic factories in the CHIPS and Science Act, the Inflation Reduction Act, and the Infrastructure Investment and Jobs Act, notes Yardeni.
“Productivity improvement could usher in the next phase of earnings growth,” says Bank of America strategist Savita Subramanian. That’s because it boosts profit margins. The other big benefit is it puts downward pressure on inflation. When productivity rises, companies feel less pressure to pass on increases in their own costs. This cools inflation, and it will ease worries the Fed will hike the economy into a recession.
Reason #6: There will be no banking crisis
Popular forecasters with no real expertise in banking or economics like Elon Musk and Tucker Carlson have been frightening people by predicting a severe banking crisis that may cause the economy to collapse. So far, they have been wrong, and that will continue to be the case.
I’ve followed corporate insider buying trends on a daily basis for over twenty years. During May, regional bank insider buying was so robust, it was one of the strongest sector signals I have ever seen. They know their businesses better than me, and certainly better than Musk and Carlson. They would not be buying huge amounts of stock if the bank sector was going to blow up. Not going to happen.
Bears also tell us that even if banks don’t blow up, their tightening of lending standards will ding the economy. Wrong again. At least so far. Bank of America internal data shows that the average amount of loan disbursement deposited into small business accounts has not shown a material slowdown over the past year. Small business spending in May was roughly in line with a year ago.
The bottom line: We are in a new bull market. While indiscriminate buying made sense back in October through December when I was strongly encouraging you to get long, there is no reason to chase stocks now. It makes more sense to buy weakness.
Besides energy, the group that looks particularly attractive is small caps. They remain historically undervalued relative to large caps. Small caps recently traded at a 12% discount to their history, while large caps traded at a 6% premium, says Bank of America. That will change as bullishness increases, and people get more comfortable owning smaller names. This favors us, because while I suggest names across the market cap range and across sectors, I focus on the insider signal and this works best at smaller names.
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