Financial Watch

It is important to remember back a few weeks ago how poor things looked on the horizon in the stock market. Only a month later we are at record highs for the Dow and even more importantly approaching an all-time high for the S&P 500. It has been a long time coming, but we’re finally at the critical moment that propels the averages to unthinkable levels. It should be no surprise to our readers that Financial Watch is once again proclaiming that the Dow will surpass 20,000 this economic cycle. Many believe the market is only capable of moving up 10% per year. Ridiculously low expectations are a key ingredient as to why we believe the first truly global expansion is going to force investors to significantly revise upward what the markets are capable of. As important as it is to believe that the economy is never what it seems on Wall Street it is also necessary to remember what can happen during bull markets.

Financial Watch strives to report what is happening in the markets without being overly biased. This is one time we’re going to throw that out the window. It is in our readers interest to understand what is going to propel the markets to 20,000 and to understand ahead of time signs that bull market has peaked.

1) Individual Investors Do Not Trust the Markets February’s sell off destroyed all trust built up among individual investors willing to previously tread water after being betrayed during the last bull market. Investor sentiment among ordinary investors is a valuable contrarian indicator.

2) Aggressive Buybacks Flush with cash companies are aggressively buying back shares. In previous cycles CEOs raised dividends in good times, this time around executives are choosing to buyback stock instead. The real reason behind this is to boost the value of stock options. However, investors stand to benefit either way.

3) First Ever Global Expansion Global GDP is on track to grow about 5% this year. We’ve never had a period where Europe, Asia, and North America are all growing the economies together. Emerging markets, particularly China, are growing so fast that their own governments cannot rein in their respective expansions.

4) Stellar Balance Sheets – Corporate balance sheets are healthier than they have ever been. Profit margins are strong and only a few firms face challenging business environments. It is rare to go through a period where significant sectors of the economy are not struggling.

5) Improving Wage Growth Analyst usually point to the job market as an indicator of how the stock market is doing. Though the two factors go together, wage growth is more important. We’re finally seeing effects of a tight job market in highly skilled professions push wages higher. At least some of this discretionary income will find its way into the stock market.

6) Strong Merger & Acquisition Activity Never before has private equity taken such a large role in M&A activity. As more companies go private this forces investment managers to redirect money into existing stocks. Right now we are seeing even the most challenged companies propped up through buyout rumors.

7) Popularity of Leverage Hedge funds are putting more leverage into the financial system than we’ve ever seen before. To date this leverage has been used to push short interest to abnormal levels. Financial Watch expects leverage to increasingly turn long, recreating a stock market bubble similar to that found in the 1990s.

Favorable Exchange Rates The U.S. dollar no longer goes as far as it used to. This trend is far from over. Investors stand to benefit from a lower dollar as it boosts earnings from overseas operations.

9) Conservative Analyst Expectations There’s no point in debating whether Wall Street analysts are of any value. It cannot be done. However, their influence is immense. Analysts focused on anemic growth in the U.S. have lowered profit expectations to be aligned with domestic growth. Only problem is that the international economy is so strong. In coming months expectations will move higher. Investors should move in before analysts can raise estimates.

10) Reasonable Valuations P/E ratios are the best measure of stock market fundamentals. At 15-16x trailing earnings this is slightly below long-term averages. Considering low interest rates, 18-20x earnings would still be considered a quality value for the markets. Not to mention, Financial Watch expects euphoria to in time push valuations above 25x earnings (2009 or 2010 by our guess). In every economic cycle there is at least one moment when investors throw caution and reason out the window.