Speaking at LPL’s annual gathering in San Diego, JPMorgan’s chief global strategist, Dr. David Kelly, seemed to apply some Southern California sunlight to disperse the cloud of gloom in consensus thinking about the economy and markets.
“I think there’s a misperception about where we are,” said Kelly, long a popular speaker on the advisor lecture circuit.
Citing survey data showing that just shy of half of all Americans think we’re in a recession and another large chunk are unsure, Kelly lamented: “We’re in the sixth year of expansion but people still think we’re in recession.”
The strategist noted that with unemployment down to 6.2%, a hair above the 6.1% average of the past half-century, “We’re much closer to full employment than most people realize.”
And not only is the economy stronger than most realize, but he views the stock market as less scary than is commonly perceived today.
Indeed, JPMorgan is “cautiously overweight” U.S. equities, though Kelly doesn’t expect the next five years to match the past five years, Kelly thinks stock growth can hit the mid-single digits over that period, on average.
“This is a climate in which earnings are rising; operational earnings will be at an all-time record high,” he told the LPL Focus breakout session.
“People say: How can this lousy economy produce profits?”
The Irishman answered with a comparison to his native country:
“It always rains, everything is always green. You need a mild damp climate for growth. [Similarly, this economic] environment allows profits to grow.”
Kelly estimated average U.S. equity price-to-earnings ratios at 15.1 — less than their long-term average of 15.6; this despite a perception that U.S. stocks are overvalued.
“That’s a fair value in absolute terms and a good value relative to fixed income,” which he is underweighting, viewing bonds as vulnerable to interest rate hikes he expects next year — potentially as early as March.
It is the persistent sense of gloom that has accompanied the five-year economic recovery that makes Kelly’s economic and market forecast as positive as it is since the slow progress just lengthens and slows the post-recession rebound.
“People and companies are hoarding cash. As it leaks into the financial system, it fuels equities’ rise,” Kelly said, adding: “I know it doesn’t feel good, but invest not on how you feel but by how you think.”
The market strategist urged advisors to help their clients see the risk of inaction.
“People want to hang out in cash and time this thing,” he said.
“You can’t make money by saving, only by investing. When cash pays you nothing, get invested in something!” he urged. “Cash is still paying you nothing and it’s time to get invested in something.”
While Kelly was bullish on the U.S. economy in the short term, in the longer term he believes that 2% GDP growth will be the new 3%, the old trend growth rate which he expects will give way to demographic changes. That shift should occur once the U.S. gets to full employment sometime in the next two to three years.
The labor force has been growing at a crawl till now — at a rate of two-tenths of one percent over the past few years.
Once again, Kelly argues the common narrative one hears of people giving up looking for work is based on misperception. Rather, what’s really going on is “a demographic gale of baby boomers eligible for Medicare and leaving the labor force,” he said.
In other words, growth in employment is masked by the 33% jump from 2010 to 2012 in people turning 65.
Another among the cherished views Kelly sought to debunk is the notion that the rising housing market is running out of steam.
After plunging in 2007 from a level of 2.3 million housing starts and slowly rising from its nadir to the current 850,000 housing starts, Kelly thinks housing will need to roar back closer to the 1.4 million starts the sector has averaged over the last 55 years.
“We are not in equilibrium position,” he said.
“It’s almost a conspiracy,” the JPMorgan strategist said, referencing the “collective actions of the federal government and Federal Reserve, which are suppressing housing."
"The federal government is engaged in a witch hunt against the banking sector; it’s a stick-up job,” he added.
The banks, he said, were guilty of some poor lending practices, but because of disproportionately heavy fines, the banks have reacted by withholding lending from all but buyers with the best credit in order to avoid future liability.
And the Federal Reserve was engaged in “price-fixing; it is completely manipulating the mortgage market,” he said, explaining that if 30-year rates average 4.25% but the Fed is targeting a federal funds rate of 3.75%, banks will conclude that the resulting 50-point spread is insufficient to earn a profit, so lending is weak.
While the pent up demand for housing, automobiles and the like should keep the U.S. economy cranking for the next two to three years, a rosier scenario than many expect (“people fear the U.S. is going bankrupt — it’s not”), Kelly argues that the world economy as a whole, not just the U.S., is in growth mode.
“People say: ‘Are you kidding?’ because they think the rest of the world is in flames,” he says, citing troubles in the Middle East and Ukraine. “It isn’t; good money is to be made in boring places.”
Kelly was particularly bullish about Europe, which, having suffered two recessions, is now only in the “first inning” of growth compared to the U.S.
“There’s a lot of room for cyclical expansion,” he said, adding: “People need to invest in emerging markets and Europe for the long-run because of cyclical growth and secular growth.”
Check out Gundlach: Golden Age of Housing Is Over on ThinkAdvisor.