A Tremendous Opportunity for Stocks
Goldman Sachs' chief equity strategist thinks there's potential that the U.S. could enter a bear market. Judging by CNN Money's Fear and Greed index -- not to mention the yields on Treasury bonds -- investors are very nervous about what will happen in the Eurozone, China, and in our own labor market over the next 12 months.
Are we at risk of falling into bear territory? Earlier in June, I asked that question of Eddy Elfenbein, who writes about stocks at Crossing Wall Street and was named by CNNMoney as "the best buy-and-hold blogger" on the Web.
Watch our conversation here (run time: 6:42), or read the transcript below:
Brian Richards: So you're a long-term optimist about the U.S. Let's shrink that a little bit and look at say the next one to three years. Goldman Sachs' chief equity strategist thinks there's a pretty good potential that the U.S. could enter a bear market. What is your view of the short-term period and whether we'll hit bear territory?
Eddy Elfenbein: It's interesting because I don't remember Goldman Sachs telling me about the last bear market. [laughs] I think they were pretty sure we weren't going to get that. Though I'll give the easy answer: I have no idea. And this is a good thing for individual investors. And this is the message to them is good news: You don't have to get that right. You don't need to know if we're going to go into a recession. You don't have to know what the Fed's going to do. You don't have to know who's going to win the election. I have good news to bring people. You don't have to know that.
Let me give you the outlook of what we have. I'm always an optimist for America, but right now the market does face some challenges. And right now the economy has done a very good job -- the corporate economy -- of rebounding from the recession. Basically, as I mentioned, corporate profits were for the S&P 500 would be about $105. This is too far out. Next year they think it'll be about $118 per share. You know, the index was right about 1,300 today. Well, in 2008 they earned $50, and in 2009 I think it was $56, so we basically doubled in just a few years. That's how much we've rebounded.
Companies have done an excellent job of growing their profits, and that's what companies are -- they are profit-growing machines. The problem is they've done this by cutting, and for most companies a principal source of overhead is labor costs. So the bad news is they've cut back on labor costs and we've seen the jobs market is one of the worst jobs markets we've seen in decades and it has not recovered with anything like a momentum that we should see.
While these companies have cut their way to profitability, now we've reached the turning point. The thing about increasing your margins is that it's great business strategy but you can't do it indefinitely. At some point a company can only cut so much and they have to grow, and that means they have to get either the existing customers to spend more or they have to get ideally new customers in the door. And that's why the economy has been so tied to the jobs market. And Wall Street has been paying so much attention to that first Friday of each month is when the jobs report comes out.
Up till now the jobs just have not been there. So it really is ... our future is tied to the jobs market. We can just sort of grind out, growing at a nominal rate of maybe 2% or 3% a year. And we're not going to be able to ... overall economy-wide the profit margin is about 10%. Historically it doesn't go much higher than that, so we're really not going to see those improvements. So that's the chief concern for the economy is the jobs market, and that's what our future is tied to.
Now, the good news for the stock market, and I think what really is the best news for bulls, is that the stock market runs on competition and its major competition is bonds, specifically long-term bonds. And that's what the stock market is. It's a continuous battle with bonds, and always pushing for who has the better deal. Right now the bond market soared for 30 years at almost a non-stop bull market. Just think of it this way: a 10-year Treasury is going today for about 1.6%-1.7%. People don't think of it, but that's trading at 60 times earnings. Would you want a company trading the P/E of 60 and growth rate of zero? It's not even rated AAA. We don't even get that.
Now take a look at say Johnson & Johnson, and this is as blue chip as they come. It doesn't get bluer; Dow component, very well‑run company. They've had a bunch of problems in recent years with some recalls and everything, but that's not going to sink Johnson & Johnson. Right now the company said -- this isn't some analyst, this isn't me saying this, this is right from the company said—they're going to earn about between $505 and $515 per share this year. So that's from the company. The stock is going for about $62-$63, so it's about 12 times earnings; or flip it over that's a yield of 8%. So think of the 8% versus the 1.7% in the Treasury. So yeah, OK, the Treasuries, that's backed by the US government...is that really worth 600-odd basis points, and I believe J&J is still rated AAA, which Uncle Sam is not.
And then on top of that you get Johnson & Johnson has just paid out for the 50th year in a row they have raised their dividend. So I think the stock is yielding about 3.6%-3.8% right in there. So you're beating anywhere on the yield curve. So when you look at stocks it really comes down to the math between the value you can get from companies -- and this year Johnson & Johnson is one example. This is not some hidden company that we're talking about. This is not some obscure value stock. This is a Dow component, and just look at the distance between that and people who are hiding out in Treasury bonds, it's a tremendous opportunity for stocks.
The article A Tremendous Opportunity for Stocks originally appeared on Fool.com.Fool.com managing editor Brian Richards holds no position in any company mentioned. The Motley Fool owns shares of Johnson & Johnson. Motley Fool newsletter services have recommended buying shares of Johnson & Johnson and Goldman Sachs. Motley Fool newsletter services have recommended creating a diagonal call position in Johnson & Johnson. The Motley Fool has a disclosure policy.
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