Stocks are starting the week near all-time highs despite an earnings season that has been filled with revenue misses.
“The reality is that investors are only enamored with what the Fed and other central banks are doing. They’re shoveling money out the door,” says Gary Shilling, president of A. Shilling & Co., an economic consulting firm. Investors, in turn, have adopted a “don’t fight the Fed," attitude Shilling tells The Daily Ticker.
What that approach is missing, says Shilling, is an understanding of what the economies in the U.S. and overseas are doing, which isn’t much.
The U.S economy grew at a 2.5% in the first quarter-- well below expectations of 3.2% growth though much better than the 0.4% reported for the fourth quarter. “Europe is in recession, Japan is barely growing and China is slowing,” says Shilling.
This gap—what Shilling calls the “great disconnect”--between a strong stock market and a weak global economy and declining revenues in the S&P 500 is unsustainable. “The economies of the world are basically weak and stocks are not reflecting that,” says Shilling. But in the meantime, he says “no one is going to stop a party like this.”
Investors have reason to keep buying stocks-- Earnings are still growing, though lately not as strong as expected. In the latest earnings season only 70% of companies have beat earnings expectations, and only 44% have beat revenue expectations.
That may reflect the smaller impact of the cost-cutting that, says Shilling, has been driving profits.
“[Companies] had no choice,” says Shilling. “Pricing power has been nonexistent [and] sales volume increases have been very limited so the only route to profit has been cutting costs. That has pushed profit margins to all-time highs,” which are also unsustainable. The impact, however, of that cost-cutting has also been declining, explains Shilling.
Bill McNabb, the CEO Of the Vanguard Group, writes in today’s Wall Street Journal op-ed that companies aren’t spending more on equipment or labor because they “can’t see a clear road to economic recovery.”
Uncertainty about regulatory policy, monetary policy, foreign policy and most importantly, U.S. fiscal policy has created a “$261 billion drag on the economy equal to $800 per person,” writes McNabb. That’s robbed the economy of 1% in annual growth in 2011 and 2012 and 45,000 jobs per month—or 917,000 jobs in total, says McNabb.
Despite the disconnect between global economies and markets, Shilling recommends that investors continue to buy stocks but only in sectors that provide cushions: equities with increasing dividends or health care stocks and consumer staples. He’s also long 30-year U.S. Treasuries and has been for 32 years. Shilling, like many others is also making money shorting the yen and buying Japanese stocks.
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