What If Things Are Getting Better?

We have for over a year asked the question, "What if things are getting better?"  We have long felt that investors have been ignoring the possibility of better than expected economic results.  We are currently seeing concrete economic news that housing is on the mend.   There is the new energy boom that is a transformative event for the US economy.  Finally all that gloom and doom talk about the end of the year increase in payroll taxes seems to not be having the effect that many expected as US retail sales increased 1.1% last month, sharply higher than expectations and the largest increase since last September.

Now the investment community seems to be coming around to our point of view on this.  Business Insider.com reports this morning that Morgan Stanley thinks we may be closer to the end of this five year economic crisis.  Morgan analyst Vincent Reinhart per an article in Business Insider notes the coming inflection point for the US Economy:

In the Morgan Stanley forecast for the US, the trajectory of economic activity marks an inflection point midway through 2013. The severe financial crisis of 2008-09 necessitated significant downward adjustments by the private sector to the levels of aggregate demand and efficient supply. As the event recedes further into history, however, the drag on growth from these ongoing level adjustments plays out.

In our forecast, the expansion of real GDP steps up to around 2-3/4 percent in the second half of this year and beyond. Indeed, the resilience of the private sector in our market economy probably would have been more evident by now had not Washington politics intruded. Uncertainty about fiscal policy last year and the reality of budget consolidation this year places the US currently in the middle of three quarters in which real GDP growth averages about 1 percent.

It is hard to say with a stock market up nearly 10% for the year how much of this kind of thinking is already baked into stocks.  One intriguing thing to think about is that as fears of the financial crisis sink into the past whether stocks will command a higher price multiple.  For example during much of my investment career it was not uncommon to see stocks trade with a 16 PE on forward estimates.  A multiple expanding environment is not unreasonable to assume where interest rates are so low and expectations for a stronger and more viable economic expansion begin to be established.  A 16 PE on our 106.50 end of the year S&P 500 estimate would give you a price target of S&P 1,700.  Not saying that's going to happen and that is not our expectation at this time.  However, it is something not beyond the realm of possibility if we continue to see further improvement in the economic tone.  It is a much higher likelihood if Washington gets its act together on the budget, the deficit and taxes.

By the way if the economy does start to expand at something beyond our 2% GDP expectations for this year then it is probable that our current S&P estimate is too low.

*Link:  Business Insider.com:  Economy At an Inflection Point?

**Long ETFs related to the S&P 500 in client and personal accounts.