[click graphic to enlarge]... but the current earnings yield less 10 yr treasury at 6.1% is as high as the earnings yield less 10yr treasury in 1974
[click graphic to enlarge]... and the dividend yield less the fed funds rate (proxy for bank deposits) is much higher than in 1974
[click graphic to enlarge]The economists at UBS predict a full blown US and global recession with a marked decline in non-financial S&P 500 profits in Q4/08 and little hope of a recovery till late 2009. However, they note that they do not expect the recession to be severe as the market suggests – the key factor being a restoration of confidence. The UBS economists take comfort in knowing that government officials around the world are doing everything in their power to bring back confidence into the financial system.
Potential Catalysts For A Sizable And Lasting Upturn
1. Slow healing of financial system and lower risk premiums
Keep a eye on:
- bank loan and deposit base growth
- loan loss provisions vs. charge-offs – continued reserve build
- tighter TED and credit spreads
- lower mortgage rates, and
- Fed loan officer survey
Since economic indicators such as GDP, unemployment, housing prices and mfg. ISM are likely to trail stocks, investors should look for higher oil prices (a supply shock aside) as a sign of improving global economic expectations.” Lower yields on long-term TIPS would suggest less deflation risk.”
2. Systemic effort to rework troubled mortgages
While injecting capital into the banking system will help ameliorate some of the expected credit losses and supply loan growth, The UBS strategists see the need for further efforts to put home owners into sustainable mortgages, to stabilize their finances and the housing market itself. Measures might include government purchases of troubled mortgages with broad stroke restructuring/refinancing and/or further subsidization of mortgages to drive a boom in household initiated refinancing.
3. President Obama discovers the virtues of supply side economics
The UBS strategists are looking for the incoming administration to oppose any tax increases while providing a reprieve to low and middle income households. They would also like to see permanent income and also business tax cuts (even if modest) as a means to boost investor confidence. While they support increased infrastructure related spending they view tax cuts as a more effective stimulus because the private sector best allocates resources.
Upside Risk: Stronger oil prices
While the ongoing recession has brought down the price of oil to a cyclical low, the UBS strategists expect a recovery in the oil price as the economy recovers (2009E avg. $60/bbl, normal $75/bbl). Since energy equities don’t seem to reflect a recovery in the oil price, the UBS strategists are over-weight the sector. “Strong demand driven oil prices ($70-100) are a big net positive to S&P EPS. Energy companies benefit and most Industrial companies benefit as suppliers to energy companies and providers of energy efficiency.”
Downside Risk: Higher interest rates
The fiscal stimulus packages intended to stimulate the economy will create large Federal deficits. This should not spark inflation as it will be aimed at keeping the economy from falling beneath its output potential. “However, if the spending is misdirected or wasteful it could could cause fears of stagflation and drive long-term interest rates higher. Treasury bond yields above 5% without clear economic recovery would be a big problem to the economy and asset valuations.”
Sector Weights
Overweight: Energy, Technology and Industrials
Equal-weight: Financials, Materials, Consumer Staples, Health Care
Under-weight: Consumer Discretionary, Telecom, and Utilities
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