On March 28, the S&P 500 Index closed at a new, nominal all-time high of 1569.19, topping its prior closing high of 1565.15 on October 9, 2007. While technical analysts are scanning their charts to divine whether the new peak suggests a correction or a continued surge, we see no magic in either the new peak or the last. We prefer to look at fundamentals, which remain solid. Consider that, adjusted for consumer price inflation, the index has not reached a new milestone; according to data collected by Yale Professor Robert Shiller, the 1569.19 level is 22% below the S&P's inflation-adjusted all-time high, recorded in August 2000. Meanwhile, our survey of forward-looking economic indicators suggests a continuation of moderate U.S. economic growth, which should drive continued corporate revenue gains. Profit margins appear sustainable, too, as labor generally remains affordable and inexpensive domestic natural gas is becoming more widely available. Sustained central bank asset purchases have suppressed bond yields and provided support for stock valuations. Of course, shocks arising from the euro zone and elsewhere could impact valuations.
Italy and Cyprus
Recent events in Italy and Cyprus have flustered but not hammered markets. A three-way split in Italian elections has complicated the formation of a new government, largely because the anti-establishment Five Star Movement refuses to participate. It seems probable that President Giorgio Napolitano will form a temporary "institutional government" with a limited mandate to tackle electoral reforms. As long as any new government lacks a mandate to reverse Prime Minister Mario Monti's economic reforms, investors may remain calm about Italy. In the meantime, Italy is engaged in orderly market refinancing of its sovereign debt at fairly moderate yields, back-stopped by the contingent availability of European Central Bank sovereign debt purchases.
Events in Cyprus are a bit more worrisome. Euro zone officials assert that Cyprus represents a special case because of the country's small size and its banks' outsized exposure to Greek sovereign debt and dependence on non-resident deposits. Fair enough, but Cyprus still offers troubling precedents. In effect, the Cypriot government, under cover of a restructuring of its two largest banks, expropriated the bulk of their uninsured deposits to raise cash to pay down a portion of its sovereign debt. An initial proposal,quickly abandoned, to also raid a small portion of insured deposits made matters worse. These actions raised concerns about capital flight, prompting the imposition of capital controls when banks re-opened last week. As a result of Cyprus, investors may wonder whether:
Japan and China
Meanwhile, at the opposite end of Eurasia, new leadership at the Bank of Japan is aiming to reflate the anemic economy through massive quantitative easing. The yen dramatically depreciated against the U.S. dollar, and the Tokyo Stock Price Index (TOPIX) soared, between November 2012 and mid-March. Since mid-March, expectations have dampened somewhat, owing to mixed economic sentiment indicators, with the yen rising slightly and the TOPIX falling slightly. In China, leaders' concerns have shifted slightly from supporting growth to containing inflation. Since early February, the yuan has been allowed to appreciate against the U.S. dollar; restrictions on the property market have tightened; publicly traded collateral has been required to support banks' high-interest-rate, off-balance-sheet vehicles; and there have been signs of liberalization in bank interest rates. While each measure may be positive, together they create near-term uncertainties that have depressed Chinese stocks, resulting in poor returns for emerging market stocks as an asset class.
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