Monday, July 15

To Dow 16,000 and beyond?

To Dow 16,000 and beyond?
| By Anthony Mirhaydari, MSN Money

After hitting record highs in the spring, the Dow and S&P 500 were ripe for a reversal. If June’s slide was that pullback, it may be buying time again.

Get those Dow 16,000 hats on.

The market struggle that followed May's run to new highs is coming to an end. What we saw was a healthy washout as fear and uncertainty over what the Federal Reserve might do next replaced the overconfidence seen in May. Various market indicators hit their deepest oversold levels since May 2012, creating attractive opportunities for those looking to put money into stocks again.

And now, the economic data could be taking a turn for the better as well.

Sure, there are still worries. Borrowing costs are rising. The Fed seems committed to raising the cost of money eventually. But for now, there's reason to believe the pullback is behind us and that new highs for stocks lie ahead. Here's why.

Although it relied on young, part-time positions, the July 5 payroll report was stronger than expected, with the private sector adding more than 200,000 positions. And hourly earnings are rising at a 2% annual rate, which is faster than the overall inflation rate and is providing a boost to real purchasing power for consumers.

In fact, in the context of stalling overall economic growth lately, the folks at Capital Economics are wondering if this has become a "job-full" recovery in a reversal of the fast-growth/slow-jobs "jobless" recovery we've gotten used to. This is being driven by a slowdown in labor productivity, which is finally taking pressure off workers as businesses are forced to ramp up hiring to boost production in a way we haven't seen for a long time.

That will be good for middle class Americans, but not so good for corporate profit margins. Yet a rebalancing of this relationship is exactly what needs to happen if the recovery is to continue, as labor's share of business income (shown below) is extremely depressed.

To Dow 16,000 and beyond?

This is why corporate profitability has surged to record highs as average Americans keep struggling. As this measure normalizes, wages will continue to creep higher.

The recent rise in interest rates hasn't yet had a negative impact on the two big consumer-driven areas of the economy: housing and auto sales. While mortgage refinancing applications are down, purchase applications are holding steady. Some of this is because mortgage servicing costs are still low historically, and some of this is people rushing to buy before rates rise further.

Homebuying will beget more price gains, which will beget more homebuying as people try to get in front of further price rises and interest rate increases.

As for auto sales, they jumped 4.3% in June to pre-recession levels as financing rates have yet to be affected by the rise in Treasury yields. Even if those rates eventually are, a lot of pent up demand remains for new automobiles, as sales have moved over the vehicle scrap rate only recently. That means people have been driving older cars for longer, suffering reliability issues and higher maintenance costs as the number of cars on American roads has declined.

Capital Economics believes that as this is reversed, it could bolster sales by around five million units (currently, sales are running at a 16 million annual rate).

While everyone is focused on the federal budget situation, state and local governments are ramping up construction spending and hiring in a way that hasn't been seen since 2008. This comes as tax receipts increase from recessionary lows in a way that hasn't been seen since 2004-05. Right now, tax receipts are rising at a 10.3% annualized rate.

While this isn't enough to fully offset cuts at the federal level, it should help gross domestic product growth reaccelerate later this year.

Everyone's waiting to see if Japan's doubling down on cheap money to stimulate its economy will actually result in a reacceleration of growth and the end of its long struggle with deflation. There are positive signs. The Bank of Japan's June Tankan survey suggested that manufacturers' sentiment will improve further in the third quarter along with plans for hiring and capital investment.

Manufacturing activity has expanded for four consecutive months as the rate of expansion grows to the highest level in just under two years. New manufacturing order volumes are growing at the sharpest rate in three years. Retail sales grew at a 0.8% annual rate in May, the first increase in 2013.

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