Anything But Cash

Virtually every market posted gains last week, including: U.S. stocks, foreign stocks, real estate, commodities, and precious metals—only bonds were slightly lower following three weeks of gains. The markets are well off of their lows. In recent months, market participants’ behavior has been defined by the mantra “anything but cash.” Since their peak, money market fund outflows have totaled nearly $500 billion as that cash has been put to work in the markets.

After a gain of nearly 60% from the low on March 9, 2009, the S&P 500 index is up 18% this year. Support for the continued gains last week came in the form of solid economic data. Monthly reports for retail sales and industrial production in August were strong and beat economists’ expectations. Inventories were also reported to fall more sharply than expected in August setting the stage for more growth as they are restocked.

Even more importantly, the LPL Financial Current Conditions Index rose last week to 0.9, the highest level for the year. The index reflects current conditions aligned with the high end of our base case outlook, established at the end of last year, for mid-teen gains in the stock market and mid-single digits gains in the bond market in 2009. The markets, measured by the S&P 500 index and Barclays Aggregate bond index, have already achieved these gains. However, the CCI suggests the economy and markets are on track for an outcome somewhat better than our base case outlook for 2009 and additional gains may be in store.

Why additional gains? Consensus expectations for economic growth in 2010 are low, investor sentiment is still not bullish, there remains a lot of cash on the sidelines to fuel more buying, and the CCI continues to improve (although the pace of improvement has moderated). Also, earnings expectations keep being revised higher which allows the stock market to advance without becoming expensive. The consensus earnings per share forecast for the S&P 500 in 2010 is $75.35, up about 40 cents during the past several weeks. This makes the price-to-earnings ratio on 2010 earnings a below average 14.2, leaving room for further gains. Corporate bonds are likely to continue to benefi t from a narrowing of spreads as corporate cash flow continues to recover. And commodities, including precious metals, will continue to benefit from strong emerging market demand.

Investors know that while cash is king in a bear market, it is a pauper in a bull. The opportunity cost of holding cash, which pays very little, is high while the economy and markets recover. We expect growth to continue to recover into next year.