Contrary to many investors' fears, the US stock market is probably not overvalued, according to Greg...
Contrary to many investors' fears, the US stock market is probably not overvalued, according to Greg Smith, chief analyst at Prudential Securities.
Smith argued that strengthening economic prospects in Europe, Latin America and Asia will boost the earnings of US companies.
Pessimism about the stock market's prospects is wrong, Smith said.
He remarked: "There are two reasons for this assertion. First, equity investors generally fail to see how little US economic constraints matter to many public companies. Many stock market analysts and even members of the Fed persist in comparing companies' growth to the capacity of certain resources found within the geographic US borders, such as the 4.1% unemployment rate.
"Of course not all these employees are available to US businesses, but if investors looked at the situation in that light, I am convinced they would start to understand why it is that companies have been coping with the tight US labour markets as well as they have."
The second reason for many investors' over-pessimistic stance is that most underestimate the considerable leverage US companies will have as overseas economies improve, Smith said.
"For many companies, the costs of being a multinational business are relatively fixed, particularly when it comes to maintaining distribution and marketing operations around the world.
"Worldwide production may have some ability to increase and to shrink costs in line with changing business conditions, but the remaining business expenses are largely fixed.
"As revenue picks up in the rest of the world I believe investors are going to see a lot of operating leverage within companies and we will start to grasp the significant extent to which the economic weakness around the world hurt earnings over the past couple of years. If I am right about the overseas leverage, there are going to be broad-based earnings surprises once mid-2000 arrives."
The monthly US employment report released in early January showed results characteristic of the employment alignment that has existed in the US for the past several years, according to Smith.
He said: "Employment data indicated extremely strong employment growth and modest wage increase - signs of an economy that seems pretty healthy. But it is not only the message of the numbers themselves that matter to the financial markets but the message of the numbers as perceived by the Federal Reserve Board.
"The threat remains with us that the Fed will perceive that the economy's growth is bound inevitably to lead to inflation. In the heat of the moment, one could get worked up about the wage increase being four-tenths of a percent.
"Viewed on a year-over-year basis, however, the wage gain in this particular report is very much in the middle of the historical level over the past several years.
"As for the source of employment growth, manufacturing remains weak and services remain pretty steady, measured year over year. So little has changed in these numbers that it is remarkable investors pay so much attention to them. However, the Fed has us in a state of constant alert that something could happen any time on the inflation front."
The real issue for the credit markets is the increasing evidence that economies in the rest of the world are showing signs of life, Smith said.
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