The fog of war has enshrouded everyone and everything. But we must soldier ahead. And that means investors, too.
The economy looks good, despite the gloomy forecasts of those who can’t see the positive indicators through the fog of pending military action against Iraq. In fact, with the economy so promising, and share prices so inviting today, we might be looking at one of the best windows for investing in a very long time.
The latest report on gross domestic product was twice as strong as expected. When you take out the reverse algebra of trade-balance accounting, domestic GDP is up nearly 3%. Capital-goods investments by businesses have increased three straight quarters at an average 9% gain. Inflation is less than 1.5%, a miniscule amount. And both the money supply and commodities — including aluminum, copper, steel, tin, and zinc — are rising, meaning that some of our cash-strapped businesses are getting back in the money.
Fourth-quarter profits were up 14%. Durable goods retailers (automobiles, trucks, and office/business equipment) were up 10%, the healthcare sector was up 18%, telecoms were up 16%, and airlines were up 39%. There is no way we are heading into a double-dip recession.
Is there a temporary oil shock? Yes. But the oil futures curve is inverted, meaning prices are summiting the hill and will soon be headed back down. Oil is now $36.50 a barrel. That price will be $33 in June, $30 in September, $28.60 in December, and all the way down to $23 and change in 2005.
Here’s another point on oil: Yes, the recent rise in oil and gasoline and home heating-fuel prices may pinch consumers temporarily. But in constant dollars, today’s $36 a barrel oil price would equate to $50 a barrel on the eve of the Persian Gulf war, and over $90 in 1980. The current oil shock is actually less shocking when put in perspective.
We learned during the first Gulf War that Wall Street can quickly shake off the fog of uncertainty and turn in an impressive rally. Not only will that rally take place when Saddam and his henchmen are removed from power, but it could be even more impressive than the market spike twelve years ago.
Economic conditions are a lot better today than they were on the eve of the first Gulf War. Real GDP was 1.8% then, now it is 2.4%. Inflation was 4.3%, now it is 1.7%. The 10-year Treasury note was 8.5%, now it is below 4%. And the banking system is much healthier today than it was in 1991.
On the economic-policy front, Washington is currently much more stimulative than it was over a decade ago. Back then the Federal Reserve was tight with the cash. Now it is loose. Back then Papa Bush was suckered into a tax hike. Now Bush the Younger is cutting taxes everywhere he can.
As the booming ’90s came to a screeching halt we learned that investors cannot always bank on the promise of capital gains — or shareholder returns based only on rising equity prices. But they can bank on a dividend check from those companies that pay them. The same holds for a corporate-bond coupon check. If stock prices rise and capital gains occur for investors, then all the better. But if the investor dividend tax is abolished in Washington, shareholders will be rewarded with a steady flow of real money from corporate America.
This is why investors should focus on cash-yield plays. It’s almost a Dogs of the Dow strategy, centering on dividend yields and corporate-bond coupon yields. Not, however, on Treasury yields. There’s been a mini bubble in Treasury prices and they are way overvalued today.
Last year, the S&P 500 had an earnings per share of $45.80. This year, with 3% economic growth and 12% corporate profits, earnings per share could be $51.90, a 13% gain. With the humongous stock market correction of the past three years, the S&P 500 is now back to its long-run trendline growth of 7% per annum since 1969.
Cyclical stocks, big-cap techs, commodities, industrials, and consumer discretionary stocks are all ripe for the picking today. And so are corporate bonds with juicy coupons, especially non-callable bonds, and even high-yield junk bonds. These are all good plays for investors.
And here’s one more comparison with 1991 that should get investors moving: Our high-tech, precision-bomb military capabilities are gargantuanly better today than they were for the first Gulf War. Saddam is history. America knows it, Bush knows it. Saddam may not know it, but he will soon learn it. Investors must believe it too.
There may be more than a two-week time horizon for investors to get active again. Is it time to buy? Yes. Buy, buy, buy.
— Mr. Kudlow is CEO of Kudlow & Co.