October of '98?
You're talking about a rally right? I think so. A rally in LTXX and a rally in the market. I agree with Joe here...
by Joe Battipaglia
Chairman of Investment Policy
Monday, August 09, 1999
We Foresee a Massive Rally
gruntal.com
Once again the market defies logic. First we have the greater than expected expansion of jobs
created. Second, we have rising wages, which means more money entering the economy
resulting in on-going expansion. Consequently, the bond market fluttered in fear of Fed action, and
the stock market fluttered along with it. To put it in past perspective, it is important to analyze these
numbers on a year over year basis. Let us further examine these specific factors: Productivity year
over year is up 2.9%. Using the second quarter data through the previous three quarters, we find
unit labor cost is up a whopping 1.4% Therefore, productivity is covering labor costs and indeed if
we go further, the profit report in the second quarter came in north of 15%. This suggests
companies are finding ample ways to handle any raising wage situations. Moreover, for the first
time in several quarters, we have had an increase in manufacturing as well as employment, which
does not speak to an extraordinarily heated economy in our view.
This week we have more numbers to ponder. Clearly the most important will be the Producer Price
Index on Friday which will be severely distorted by the drought on crops and energy prices
returning to their pre-1998 levels. Excluding food and energy, we are looking for 0.2% increase in
the PPI for the reporting month of July, nothing extraordinary about that. In addition, we will be
receiving retail sales on Thursday, which should show moderation on the consumer side. When
you couple that with the fact that mortgage rates are up over 8% and the impact that has had on the
housing market, the benign producer price number on August 13th and CPI on August 17th lead
me to conclude that the Fed does not need to take action on August 24th . However, if they act, it
would only be a quarter of a point move without a change in bias.
We think the Fed is well aware of the economy's moderation and the fact that there is no evidence
of inflation in the economy. Meanwhile, as far as the stock market is concern, enough is enough.
As we pointed out a week ago, two-thirds of the S&P 500 have P/E ratios that are in the low
twenties and high teens. Excluding the blue chip global companies, we do not have multiples that
are extreme by any measure. In addition, analysis by DLJ exhibits that 36% of NYSE equities are
above their respective 10-week moving averages, and 64% are below their 10-week moving
averages. We have had a classic correction as we go through this part of summer after having
reached new highs.
The stage is set for another massive rally based upon the following conclusion:
a.There is no move by the Federal Reserve to tank the economy into a recession.
b.The PPI and the CPI do not signal an inflationary spiral excluding the oil and food volatility.
c.The economy continues to grow at a surprisingly 3% GDP rate yielding a 15% improvement
in profits.
The third quarter can play out just like the second quarter where everyone frets about rate and
earnings and the Feds tells us what action they are going to take. In turn, companies tell us the
positive state of business conditions and the market responds by rallying.
There is no change in our year-end target of 12,000 on the Dow, 2,900 on the NASDAQ Composite,
and 1600 on the S&P500. We still think a 5 ¾ % long bond is in the offering as the economy
simmers down and these numbers start to stabilize. We recognize that valuations are considered
to be rich. We think you have to look past the aggregate numbers and focus on what fraction of the
market is valued. Our conclusion is there is still a great deal of upside in the sectors that we focus
on such as technology, pharmaceuticals, financials, and transportation because they will deliver
double digit earnings results in this environment.
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