What’s Different This Time?

Value Line Low Total Return Screen (10/11/2013)

Be specific.

It’s a question that revolves around that prolonged flat spot in the return forecast from 2004-2007. (See accompanying Value Line Low Total Return forecast graphic below) The return forecast in the second half of 2002 was in the 10-14% and proceeded to subside down to approximately 4% in mid-2004. From those return forecast lows in March and December 2004, the overall market proceeded to gain at an annualized rate of 14% between Halloween 2004 and Halloween 2007.

And then the wheels came off.

Here’s something that is specifically different, this time around. The year/year change in earnings was pretty robust in 2004-2006 … and the recession comes clear in 2008-2009 as earnings contracted significantly. The 2010 recovery was also pretty robust.

But we’re not seeing that now.

From the perspective of profitability, this recovery is pretty weak according to the forecasts for 2013 and 2014. And yes, we do keep in mind that the year-ahead forecasts are almost universally optimistic at the beginning of the year, generally waning as we turn each page of the calendar and the actual results come home to roost.

At yesterday’s Big Picture Conference, Stephanie Pomboy of MacroMavens pointed out that it’s even worse than it appears. She observed that “60% of earnings improvements over the last few years have been propped up by easing and low interest rates. A big portion of earnings improvements over the last few years have been reduced interest costs.” Pomboy believes that a sudden removal of the punch bowl could have dire effects on the overall market.

As we continue the weekly updates, we once again note that “NONE” makes another appearance with respect to “Materially Stronger” companies in the current batch. With a nod to the reality that some erosion of expectations is historically natural as the year goes by, those 2014E year-end estimates are still nothing to write home about — and the atrophy hasn’t started there, yet.

Compare the profitability trend for 2004-2007 to what’s happening now … and one of the conclusions I reach is that the current 4.2% for VLLTR is different this time, versus the flavor seen in 2004. The probability of that same type of market advance from 2014-2017 does not seem likely, without an underlying strengthening shift in fundamentals.

Continue the quest for highest-quality, superior return stocks … and I’m having trouble arguing with Value Line’s recent uptick in the recommended asset allocation for cash equivalents in portfolios with a capital preservation focus.

Companies of Interest

Materially Stronger: NONE

Materially Weaker: Kinross Gold (KGC), Pan American Silver (PAAS), Potash (POT), Silver Wheaton (SLW), Alcoa (AA), Manulife (MFC), Newmont Mining (NEM)

Market Barometers

The median Value Line low total return (VLLTR) forecast is 4.2%, unchanged from the last week (despite the drop in the stock market which should generally cause the VLLTR to increase.)

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