The Underappreciated Upside Risk



Published On

June 9, 2014

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StreetwiseSATURDAY, MARCH 5, 2011 | By MICHAEL SANTOLIThe Underappreciated Upside RiskIt’s tempting to listen to the bullishness of money managers and analysts and take a bearish positionagainst the crowd. Whatever fails to kill this bull market, it would seem, makes it stronger.Egypt, Libya, Iran, oil prices above $100 a barrel, the threat of squeezed corporate profit margins, the fearof a game of “federal budget chicken” in Congress-all of it has energized sellers in recent weeks, yet notenough to disturb the general upward bias in share prices.This little period of congestion in stock prices could hardly fit more neatly into the logically bulletproof casefor a stall or pullback in the tape, one made here for several weeks.Here we are, almost exactly two years from the sickening bear-market low, with the total value of U.S. stockshaving doubled almost to the second decimal point, and pretty much exactly three years since Bear Stearnsfailed, with the Standard & Poor’s 500 at almost the same level. The excuses to “sell on the news” are rife.On one-day pullbacks, signs of “distribution”-smart money selling to the less smart-has been evident.Strong corporate profits are both undeniable and largely priced into stocks; the Fed is the phantom bidderfor stocks, but might soon back away. Wiseacres such as this column’s author are fretting over how optimisticthe average investor has become and are busy being pretty cute insisting this means that the short-termoutlook for stocks is not terribly favorable.Throw it all in the mixing bowl, and it still seems we are in a market climate much like the one that prevailedin the middle of the last decade. Market volatility is being smothered by free money out of the FederalReserve. A “jobless recovery” is becoming a job-generating expansion, one that favors companies overconsumers. The credit markets are generous to a fault, and are ready to facilitate a buyout and corporatere-leveraging boom. With corporate profits cresting, company leaders are starting to feel their beer muscles.If the mid-2000s script plays out, it would suggest most of the upside from this economic cycle is in thebooks, given that the S&P 500 only doubled from 2003-2007 before the recession and bear market struck.Yet perhaps the most unexamined, or at least undiscussed, scenario for the corporate economy and forstocks is the unalloyed bullish thesis. Without fully endorsing it, here it is:Job creation has begun to accelerate just as it did in the 2004-2005 period. Personal-consumptionexpenditures just reached an all-time, inflation-adjusted high. February’s strong auto sales show a spring-loaded condition of pent-up demand in the economy. Corporate profits are swollen and continue to outpaceforecasts. Buyout and other deal activity is only now starting to gather momentum. The Citigroup EconomicSurprise Index, charting macro data releases versus consensus estimates, logged an all-time high last week. This all argues in favor of the bulls, even if we have to endure some kind of stutter-step or backsliding inthe meantime. It’s tempting to look at the general bullishness of money managers and strategists, based onsurveys, and decide to stake out the bearish opposition to the crowd. And yet, the crowd is cautiously ratherthan aggressively optimistic, meaning it can be proven wrong either by a bad market or a fabulous one.Note that the run of new exchange-traded-fund launches (and, for that matter, advertisers in Barron’s)has been dominated by hedged vehicles, or those not dependent on a rising equity market. These includea FactorShares suite tracking the spreads between stocks and bonds, stocks and oil, and the like. What’smore, the equity allocation of the members of Tiger 21, a network of ultrawealthy investors, sits at 21%,against a historical average of 30% to 35%, according to a spokesman.The rationale for taking some profits off the table after the market has doubled and the world’s gotten outof hand is pretty solid, yet the rest of the evidence suggests “upside risk” might be underappreciated at themoment.IF THE WORLD, AND THE AMERICAN CONSUMER, continue to forgo their many invitations to collapse,then shareholders of Target (ticker: TGT) should be amply rewarded. The stock has been unjustly in thepenalty box because of the company’s efforts to generate more customer traffic via grocery sales and arewards program. Target is selling its credit-card business (which will lower its cost of capital) and isexpanding opportunistically into Canada.The next couple of months’ results could be noisy, but at 51.65 and less than 13 times the past year’searnings, Target shares price in very little future growth for the franchise, which is sure to deliver plenty.A move above 60 seems likely.