Europe is a problem that will be with us for decades, but not one that will derail a global recovery Paulsen argues, pointing more to emerging markets like China and India which have seen bad growth metrics recently, and arguing that the biggest substantial risk to markets at this point, especially the S&P 500, would be a recession in the emerging world. However, the caveat here is obviously last Fall’s strong, accommodative policy measures (easing, etc. as opposed to the late 2010 rate hikes) and the projection that China’s slowdown is already bottoming-out, with a potential nadir being around Q4.
The probability curve is pretty clear to Paulsen on such policy initiatives already getting ahead of the problems at some level, ensuring that the growth potential in emerging markets isn’t something to be too worried about. So if the Euro fear flare up cycle is largely digestible and emerging markets can pull out of the dive easily enough, the other two major factors from Paulsen’s point of view are an under-quantified robustness in the domestic economy coupled with exceptional earnings multiples.
Pointing to $100-level trailing 12-month earnings per share estimate for the S&P 500 in a recent research note, that gives us a price-earnings multiple of around 13 times on trailing earnings (year-end consensus-estimated earnings of around 12.3 times), Paulsen confidently characterized it as a cheap buying opportunity. In fact, he characterized Europe as such and argues generally that too much of an internationalism bent exists, where too much focus on external economies in Europe and China for instance, has upset domestic perspectives.
Paulsen made a strong case that the initial overstatement of U.S. growth data, followed by a huge failure to adequately state the realities of the problem, effectively short-circuited perceptions to a large extent, and he remains very bullish on the domestic economy. People may be selling the market based on low GDP projections but Paulsen argues the U.S. economy is doing “far better than people think,” pointing to his own figure of around 2.5% growth, and underlining several elements that could push it as high as 3%. Stimulating factors cumulatively make this possible according to Paulsen, like mortgage rates under 3.75% (5% last year), money growth at around 10% since Fall (was growing at only 5% a year ago), a dollar that is still off 10% from 2010 highs, falling prices at the pump on fuel, and the recent Case-Shiller 20-city Index (Mar – April period) which shows a 1.3% jump in home prices, breaking a seven-month down trend streak.
Also noted was the inflation rate falling from 4% last Fall to 1.7%, which, alongside China being able to buck the down trend and interest rates being so low amid prime earnings multiples, gives credence to the argument that the S&P 500 could rally through March highs of 1,440 in the second half of the year. Paulsen said that the combination of low interest rates/inflation and choice earnings multiples has never been seen before in the post-War era.
The component vector is tactile to Paulsen who argues that investors aren’t going to care about Europe with a modest domestic recovery and returning emergent growth, with only China’s reliance on Europe as an export market raising concerns.
Looking for a momentum pickup in emerging markets next year, upward revision of GDP targets, a settling-down of financial fear in the Euro zone, and underscoring the attractiveness of the S&P 500 valuations, Paulsen held fast on his 1,500 target for year-end.
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