From the March 2013 issue of Futures Magazine • Subscribe!

Equity bulls’ suspended sentence

Buy buy buy

Robert Reynolds, principal of value-based long equity fund Loyola Capital Management, sees strong equity performance in 2013. “The market is going up because stocks are undervalued,” he says. Typically the average price earnings (P/E) ratio for the components of the S&P  500 Index runs 15 to 16 times earnings. In early February, they were between 13 and 14, Reynolds notes, adding that in this low interest rate environment, P/E ratios can rise as high as 20 to 25. “Stocks are significantly undervalued. Related to fixed income, stocks have never been this attractive. Investors have been out of the market, [and]as they move back in there will be huge demand,” he says. 

A P/E ratio of 20-25 would translate to the S&P 500 hitting 2160. “I don’t think they will get there,” Reynolds says, “but 18 times is possible, which translates to 1950.” He says a 30% rise in the S&P 500 is possible this year. Yet, he is most bullish on economically sensitive sectors such as auto parts and technology. “We believe the economy will be stronger,” he adds. 

Lazzara sees an improving housing market. “This will be a good year for mortgage brokers and construction. Southern California is a hub and everyone I talk to says things are humming along. It will be a good year in housing,” Lazzara says. 

Not as bullish is Benjamin Burack, managing director at market-neutral hedge fund Qubit Capital Management. “While relative valuation looks pretty good for the stock market, on an absolute value basis it is not as strong,” he says. 

While acknowledging that on a standard P/E ratio the market may look undervalued, by other measures such as Shiller’s P/E, cash yield and Tobin’s q, the market appears overvalued. “It doesn’t mean 2013 will be a bad year,” Burack says, “[but]I don’t see the drivers in place for a new bull market.”

Burack argues that equities have been in a cyclical bull market for four years but in a secular bear market since 2000. That cyclical bull is getting pretty long in the tooth and could be ready to end. Burack says this doesn’t necessarily mean a huge correction. “The market could just stagnate for 12-18 months. It is hard to argue that we are at the beginning of a new secular bull market,” he says. 

He points out that at the beginning of the last secular bull market in 1982, interest rates were much higher. “Interest rates were higher and heading lower but in the long run, interest rates [now]can only get higher. Corporate profits are at all-time highs; they may not go down in the next year, but it is hard to see [them] going higher because they are so high right now,” Burack says. 

Once again, one analyst’s bull indicator is another’s red flag.

But the question that seems to be dividing the bulls and bears or bulls and more cautious types is defining the market. Some see a screaming bull ready to take out all-time highs and continue to soar, while others see a market that has been relatively flat since 2000 after two bubble-bursting crashes with one additional shoe left to drop. 

Burack does not necessarily see another huge leg down on the horizon but says we are still working on the secular bear and points to the Japanese lost decade to show how bear markets can persist for decades and include strong bull moves while still remaining in bear mode (see “The lost decade(s), below).

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