Dow 13000?

I do not make predictions about absolute price levels for anything, but when I saw this commentary on Russell Napier’s notes on the outlook for equity markets and the similarities to my own outlook, I sat up and took notice.  He is forecasting a 30%+ increase in equities over the course of the next 18 months, which is roughly the time period I have been looking at, as well.  Thirty percent may sound like a lot in the present gloominess, but I think there is good reason to think we are, as I said before, in store for an Indian summer.

With a stabilization of credit markets, growth in M3, a gentle rise in inflation, and the undervaluation of stocks relative to bond yields, stocks are set to skyrocket.  In this return to the Old Normal, however brief, stocks will suck up all the capital heretofore sheltering beneath the low canopy of the bond market, but bonds will have to adjust to the increased demand for equities and greater inflationary pressures.

Napier’s point of view is summed up in the quote, “It’s not the economy, stupid!”

He argues that in terms of the ratio of dividends to yields (DYR), stocks are the most undervalued they have been in fifty years, and that at these levels, including the depths of the bear market of the 1970s, particularly 1974 and 1979, stocks produced 47% and 31% returns, respectively.  Last year also saw a spike in the DYR, and that produced comparable returns in the wake of the stock market crash.

As for the real economy, if the increased amount of liquidity does not directly benefit the economy, the amount of idle corporate capital eventually will.  Corporations cannot continue to leave that money idle if the credit markets and the real economy have stabilized.  Whether or not one believes that things have stabilized depends on which stats you look at, but I believe that the stability of asset prices around the world over the course of the last three months is indication enough.  The combination of stability and liquidity will be explosive and create (false) prosperity and a new round of instability, but we all die someday, as Keynes and Bush said.

When will this Old Normal come to an end?  According to Napier, when inflation hits 4% and bonds hit 5.5%, the gig will be up.  That seems rather specific to me, but it is something to watch out for.

There is one caveat I would like to offer.  When talking about the increased stability of the economy in the last three months, there is still one area that at least appears to be increasingly unstable:  politics.  We are in the midst of a rather sharp turn to the right around the globe.  We can see it in tea party politics, the recent elections in Sweden, perhaps even in the strange noises coming out of Cuba.  There has been an uptick in tension between nationalists in China and Japan, provoked by China’s determination to cause a scene in the Senkaku islets north of Okinawa.  The Middle East, of course, is critical.  Relatively speaking, things seem to be fairly stable.  The peace process seems to be warming back up (not that one should put money on that), and although King Abdullah of Jordan warned of an outbreak of war before the end of the year if there should be a setback, one should note that he claimed war was “imminent” back in April, as well.  Even if Iran and Syria were to sponsor a Hamas-Lebanon war with Israel, it is unlikely to lead to significantly higher oil prices.  In fact, the currently low oil prices are probably causing enough trouble in Iran at the moment.


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