vaughnwoods

 

It’s been a relatively easy ride upward since the stock market bottomed in March of 2009. Just two years ago, the S&P 500 dropped to 666. Well, as of this writing the S&P 500 now stands close to 1300. A rebound of that size in just two years is worth celebrating. Someone should make t-shirts boasting: I LIVED THROUGH THE CRASH OF ‘08-‘09!!!

 On second thought, these t-shirts may be a bad idea since nearly every person on the planet would be due one. Cotton prices would soar. Fuel prices would spike as transportation companies struggle to handle the volume. In the aftermath, cotton farmers would be left with the repercussions of overcapacity, overplanting, layoffs, idle equipment, debt levels, labor unrest, stimulus programs, taxation remedies, and who knows…somewhere on the planet…another crash?

When it comes to economics, trouble is easy to get into, but hard to get out of. There are always repercussions and unintended consequences. So, let’s examine the aftermath of the rapid rebound, paying mind to where we may be going and what expectations you should have about the future.

 In the United States, profit cycles tend to be associated with credit cycles. This logic is straightforward. Rapid growth in debt-financed spending by households, corporations and/or governments usually translates into a period in which corporate revenues grow faster than corporate costs. The primary driver of the last profit-margin cycle in the United States was household debt expansion. However, we now find ourselves somewhere between debt stagnation and debt reduction. Combine this with the difficulty of pushing real estate leverage due to high inventory levels, and we find that the profit cycle in the United States may have seen its peak for a while.

Near-term tax policies may also limit profit margins. Payroll and corporate taxes are set to increase by approximately $200billion as the 100% depreciation of equipment purchases and 2% cut in the payroll tax expire at the end of 2011. However, a lot can happen between now and year-end, much less between now and the end of 2012. It is noteworthy that Credit Suisse analysts now expect profit margins in the United States to come under pressure in 2012 if the Federal government acts to slow the expansion of debt. However, congressional leaders may not have the political will to curb debt without providing some form of offsetting stimulus.

Meanwhile, highly respected analyst Laszlo Birinyi, president of Birinyi Associates, is calling for the S&P 500 to hit 2854 by September 4, 2013. I hope he is correct. However, I wouldn’t count on it. From my vantage point, now is a good time to ratchet down expectations. Dividends may well become a very large part of total returns over the next 12 months. For this reason, we are holding a high percentage of large dividend-paying companies with high free cash flow.

Bottom line: we believe that we are entering the mid-cycle phase of this continued bull market. While our outlook remains positive, it is important for investors to realize that progress may look slow compared to what we have seen over the last two years.

Best Regards,

Vaughn L. Woods, CFP®, M.B.A.

*Investors should be aware that there are risks inherent in all investments, such as fluctuations in investment principal. Past performance is not a guarantee of future results. Asset allocation cannot assure a profit nor protect against loss. Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. Views expressed in this newsletter may not reflect the views off Delta Equity Services Corp. The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. VW1/VWA0129

- Marketedge.com, Pershing NetExchange Pro, Bloomberg, Credit Suisse, Briefing.com

- Credit Suisse, US Equity Strategy 03/22/2011