This is the time of year when we give thanks.
The bull market will be seven years old on March 9 next year. Thankfully, we’ve been bullish since March 2009. We have reviewed our S&P 500 forecasts at the beginning of each year since then.
We were too bullish from 2009-2012. We weren’t bullish enough from 2013-2014, as our yearend targets were surpassed in the fall of both years. Closing at 2089.17 on Friday, the S&P 500 is awfully close to our yearend target of 2150 for this year. It could easily surpass 2150 before yearend if the rally that started in late September continues into next year, when our target is 2300. That target is based on our prediction that S&P 500 operating earnings per share will rise 7.6% from $118 this year to $127 next year and 7.1% to $136 in 2017. Multiply that last number -- which would be forward earnings at the end of next year - by a forward P/E of 16.9, and the result is 2300.
I would like to thank the major central banks of the world for doing whatever it takes to drive stock prices higher. My mantra has been: “Don’t fight the central banks.” The central bankers say that their policies are “data dependent.” More often than not, they seem to have been market dependent. Whenever stock prices have swooned in the major equity markets around the world, central bankers have responded with soothing words and more easy-going policies.
We would also like to thank the folks who run corporate finance departments. They should be very thankful that the central bankers have done whatever it takes to revive global economic growth. However, the results have been disappointing. Global revenue growth has been subpar, which has dampened hiring and capital spending. So corporate finance managers have borrowed lots of cheap money in the bond market -- thanks to the central banks -- to buy back their shares and to acquire other companies.
In other words, the central banks have enabled lots of financial engineering. Consider the following:
- An abundance of bonds. Corporate finance managers must also be thankful for all those investors who’ve been reaching for yield in the bond market. That’s allowed nonfinancial corporations to borrow a record $951 billion over the past 12 months through September. The Fed’s flow of funds data suggest that about half of that was net new borrowing, while the rest reflected the refinancing of outstanding debt at lower interest rates. Since Q1-2009, nonfinancial corporations have raised a total of $4.5 trillion in the bond market, with $2.7 trillion of that used to refinance existing debt and $1.8 trillion representing net new debt. Nonfinancial corporations now have a record $8.9 trillion of debt on their balance sheets, with $4.7 trillion in bonds and $4.2 trillion in short-term liabilities.
- Record cash flow. All this borrowing has occurred as the cash flow of nonfinancial corporations rose to record highs in recent years, exceeding $2.0 trillion over the past four quarters through Q2-2015. Since Q1-2009, cash flow has added up to $11.6 trillion. Contributing significantly to that flood of cash is the rise in corporate profit margins into record-high territory over the past few years.
- Record buybacks and deals. All that internal cash flow and all the net new bond issuance financed record stock buybacks, which have totaled $2.5 trillion since Q1-2009 through Q2-2015 for the S&P 500 companies. More recently, they are also funding record M&A activity.
- Buyback & dividend yields. Joe recently compiled a new publication titled S&P 500 Buybacks, Dividends, & Earnings & Yields. He shows that buybacks plus dividends were equal to 96.2% of operating earnings during Q2. Their combined yield was 5.07%, with the buyback yield at 3.04% and the dividend yield at 2.03% (rising to 2.22% during Q3). This new publication includes the same analysis for all 10 sectors of the S&P 500.
The bears have no reason to give thanks. They’ve been expecting another 2008 calamity ever since the 2008 calamity. They’ve been fighting the central banks. They’ve missed the importance of corporate buybacks in driving stock prices higher. That’s because they believe that earnings growth driven by financial engineering is fundamentally bad because it isn’t “organic.”
The question isn’t whether it is good or bad, but rather whether it is bullish or bearish. It’s been bullish. In effect, using cash flow and bond borrowing to buy back shares amounts to a slow-motion leveraged buyout of the stock market.
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