Will the Stock Market rally continue? 5-31-13

It is a popular question and we wish we knew the answer…  However, improving economic conditions, accommodative Federal Reserve policy, reasonable stock valuations, the rotation out of long maturity bonds and relaxed earnings expectations in the second half of the year all should provide support for stocks for the remainder of 2013.  Still, the pace of equity gains will likely moderate and volatility could increase in the coming months with a short term selloff/correction likely at some point.

Despite the rally, most traditional valuation metrics still suggest that stocks appear reasonably priced relative to historical valuations and cheap compared to the alternatives, particularly bonds, which are unusually expensive at the moment.   To push equities higher we will need to see an increase in economic growth which should help earnings improve and keep stocks attractive from a valuation standpoint.  Many corporations are now operating at very efficient production levels and will need organic growth to increase the bottom line.

Emerging markets, energy, commodities and other underperforming asset classes may see more inflows of investment funds as the year progresses due to attractive valuations.

A few economic updates came out this week worth noting:

–          Consumer confidence jumped in May to a five-year high, lifted by a better outlook for hiring and business conditions. The increase suggests consumers may keep boosting economic growth this year.  The Conference Board, a New York-based private research group, said Tuesday that its consumer confidence index rose in May to 76.2. That’s up from a reading of 69.0 in April and the highest since February 2008.

–          Home prices in the U.S. rose 10.9 percent in March, the most since April 2006, according to the Standard & Poor’s/Case-Shiller home price index.

–          Globally one area of focus is the economic picture in China.  The data has been showing a modest reduction in economic output in China over the past several months.  Most analysts are in agreement that China is in a short term economic slowdown which will result in reported GDP growth of 6-8% for 2013.  The much discussed trade deficit is, indeed, too wide, but U.S. exports to China have been growing faster than Chinese exports to the U.S. since 2008 and are projected to continue for the foreseeable future.  China has about 250 million people in the middle class.  It is projected to have between 450 and 600 million by the next decade.  That is quite a lot of consumers who want American goods.  In the words of his Excellency Cui Tainkai, Chinese Ambassador to the United States:  the average middle class Chinese wakes up in the morning to American music, puts on American clothes.  If he can afford a car, he gets into an American car, goes to work and has Kentucky Fried Chicken for lunch.  It is clear from these important numbers that China remains very much a growth engine for the global economy over the next decade.   We still view Chinese stocks as attractively valued with an average price to earnings multiple of 11.81.