Anthony Mirhaydari: Bull market fueled by easy credit on the way?

Extra9/29/2010 7:30 PM ET

Get ready for an epic bull market

Overcautious investors could miss out on what's shaping up as the greatest stock-buying chance of a generation.

By Anthony Mirhaydari
MSN Money

Investors are scared. Workers are worried. And pessimism reigns. Yet in one market, a boom is under way.

I'm referring, of course, to the bond boom: For the year, the iShares Barclays 7-10 Year Treasury Bond Fund (IEF, news, msgs) is up about 14% and the iShares iBoxx $ Investment Grade Corporate Bond Fund (LQD, news, msgs) up about 12%. Compare that with a measly gain of about 2.4% for the S&P 500 Index ($INX) over the same period.

It's no wonder that investors have yanked $58 billion out of U.S. stock funds this year while pouring $172 billion into bond funds, according to EPFR Global data.

But this very phenomenon suggests we're on the cusp of a huge bull market for stocks. Here's why:

Money in the making

All of this bond buying is pushing yields lower and lower, making credit cheaper and cheaper for borrowers. Already, more high-yield debt has been sold this year than was issued in the whole of 2009. Even Dubai, the Persian Gulf emirate that rocked global financial markets last November and brought the problem of over-indebted nations to the world's attention, plans to sell $1 billion in new bonds.

Microsoft (MSFT, news, msgs), which publishes MSN Money, sold $1 billion worth of three-year bonds last week at a record-low interest rate of just 0.875% -- just a quarter-point more than the yield on comparable U.S. Treasurys. Never before has a business borrowed so cheaply, according to Thomson Reuters data going back to 1970. This follows recent low-cost-debt issues by the likes of IBM (IBM, news, msgs), Hewlett-Packard (HPQ, news, msgs) and Procter & Gamble (PG, news, msgs).

This bond bull has been in place for a while: Since August 2000, the S&P 500 Index is down nearly 17% on a total-return basis, including both dividends and capital gains. Compare this with the total return of 127% on investment-grade corporate bonds over the same period.

The good news is that periods of stocks underperforming bonds are historically very rare and don't tend to last long. After all, stocks offer something bonds can't: the opportunity to profit from earnings growth. Plus stock returns offer a measure of inflation protection, which bonds lack.

With investors devouring new credit issues and lowering corporate borrowing costs, companies have lots of free money to spend. And that sets the stage for an epic bull market in stocks -- on a scale that hasn't been seen in generations -- as CEOs use cheap credit to enrich themselves and their shareholders.

How epic? Well, a couple of analysts offered realistic numbers this week that would push the S&P 500 past 2,000, with gains of as much as 85%, based on 2011 earnings. (And then there was the analyst who made headlines this week predicting Dow 38,000, bringing back memories of the famous Dow 36,000 prediction a decade ago. I'll call this less realistic.)

Over the long term, we can expect big gains. As I wrote in "Why investors shouldn't be so glum," we're at a rare low point for interest rates and near a Depression-era low in the 10-year return of the S&P 500. Both suggest a multiyear advance lies ahead.

Bond bull on the attack

Interest rates are tricky. Fundamentally, they reflect the relationship between the supply and demand for money. But they are also so much more. They reflect inflation expectations. They reflect the level of risk. And they reflect the underlying growth rate of the economy.

So for many, the current bout of ultralow interest rates looks and feels a lot like the situation Japan has faced since the late 1980s (the subject of my column "Is America the next Japan?"). In other words, near-zero interest rates represent a deflationary/low-growth future. In that environment, stock returns should suffer.

But there is plenty of evidence that both the economy and inflation will exceed expectations in the months and years to come -- topics I've discussed in recent columns (see an index of my columns here). And that means stocks are poised to move higher.

What's critical here, as emphasized by Credit Suisse strategist Andrew Garthwaite in a recent note to clients, is that there has been a big fall in bond yields relative to economic growth or prospects for profitability. If investors were truly concerned about the future, then they wouldn't be snapping up risky, high-yield bonds.

Take Freescale Semiconductor as an example. The troubled private tech company tapped the credit market for $500 million in new bonds last week, but demand was so overwhelming that the issue was expanded to $750 million. Just more than a year and a half ago, some of the company's bonds were trading at less than 17 cents on the dollar as bankruptcy loomed. Now, despite the risks still present -- the proceeds will be used to repay old debts -- the market just can't get enough, thanks to the juicy 10.8% yield on offer.

Continued: Businesses are feeling flush 

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Businesses are feeling flush

Because of the recent obsession with bonds and the impressive return to profitability by businesses, we're in the midst of a rare situation. Corporate free-cash-flow yields are at 50-year highs versus corporate bond yields. And according to Institutional Brokers' Estimate Systemforecasts, free-cash-flow yields (which are the most conservative measure of a company's earning power) are soon expected to move over bond yields.

What this means is that CEOs can easily add to earnings by borrowing cheaply and investing in stocks, whether their own via buybacks or others via mergers and acquisitions. It's basically a recipe to easily print money -- the same recipe that typically is the exclusive domain of banks, which borrow short-term funds cheaply and use them to buy long-term assets carrying higher yields.

As you can see in the chart below, corporations have plenty of room on their balance sheets to take on some cheap financing. Leverage, represented by debt outstanding versus profits, has returned to the levels that prevailed in the mid-1990s and mid-2000s, periods that preceded stock market gains on the back of mergers, acquisitions and share buybacks.

Corporate leverage back to normal © MSN Money
Right now, M&A and buyback activity is well below peaks associated with stock bull markets. Share buybacks for U.S. nonfinancials over the past 12 months as a percentage of gross domestic product stand below 0.2%, compared with a recent high of nearly 1.4% during the housing bubble and roughly 0.7% during the tech bubble. As for M&A's, it's down to just 0.5% of GDP, compared with peaks of 2% and 3.5% for the previous two bull cycles.

Credit Suisse's Garthwaite finds that M&A activity tends to lag the business cycle by about a year. Given that the recession officially ended in June 2009, the recent flurry of activity should come as no surprise. Just this week we had Southwest Airlines (LUV, news, msgs) agreeing to buy a smaller rival for $1.4 billion and Unilever (UL, news, msgs) moving to snap up personal-products company Alberto Culver (ACV, news, msgs) for $3.7 billion.

As deal speculation gets priced into the market and businesses reduce the number of shares outstanding, stocks will move higher. Much higher.

It's happened before

The mission of corporate CEOs is to boost shareholder value. If they don't, they get fired. Or their companies get raided by buyout specialists or absorbed in M&A transactions.

Thus there is a constant focus on earnings growth -- which is a function of profits as well as how many times these profits are divided. This, of course, leads to the constant obsession with earnings per share.

Over the past two years, things have gone well for CEOs, thanks to the slack in the labor market, government stimuli and strong demand overseas. Low labor costs and record increases in productivity over the past two years (even with a drop in the second quarter) have helped push corporate profits past the previous peak in 2007.

And now the raging bond bull market gives them the opportunity to borrow money to increase dividends, repurchase shares and snap up rival companies.

Even if, as the pessimists believe, earnings growth is set to slow, CEOs can still use credit to reduce the number of shares outstanding, increasing earnings per share and, thus, stock prices.

Indeed, a historical analysis by Citigroup strategist Tobias Levkovich shows that cheaper credit does, in fact, boost equity valuations. His data show that the price-to-earnings multiple on the S&P 500 Index has a strong inverse relationship to the yield on 10-year Treasury notes plus the equity risk premium. The latter reflects how much "extra" return investors demand to hold equities.

Intuitively, this makes sense: Stock prices are a function of earnings power, borrowing costs and risk appetites.

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Right now, stocks are trading at a P/E of around 13.6 based on consensus 2010 earnings per share estimates. But Levkovich's model suggests valuations should be closer to 22, given where interest rates and equity premiums are. Based on his 2011 earnings-per-share forecast of $90.25, that would be enough to push the S&P 500 up near 2,000. Such a rise, if it happened, would be worth a gain of about 74% from current levels.

It gets better: Strategists like Levkovich, who use economic data and historical relationships to make "top-down" estimates, are less optimistic than "bottom-up" stock analysts who examine individual companies. The bottom-up consensus 2011 S&P 500 earnings per share estimate stands at $96. Putting a 22-times multiple on that estimate would push the S&P 500 all the way to 2,112, for a gain of 85%.

If these earnings estimates seem ridiculous, it's worth noting that the "optimistic" bottom-up analysts have been busy raising their forecasts over the past year as companies consistently report better-than-expected results, thanks to cost cutting. The next boost should come from operating leverage as businesses put idled machinery back to work.

And if you think Levkovich is full of it, check this out: His calculations find that the combination of interest rates and equity risk premium explains 67% of the variation in the S&P 500's P/E multiple. As statistical relationships go, that's pretty solid.

Find an edge

So, how should investors position themselves?

Garthwaite recommends focusing on stocks that are poised to benefit the most from re-leveraging via buybacks. He screened the universe of stocks looking for issues with low debt loads and high free cash flow -- companies that will be most able to increase their repurchase allocations.

In the list generated, large-cap technology stocks dominate. Think Intel (INTC, news, msgs), Oracle (ORCL, news, msgs), Cisco Systems (CSCO, news, msgs), Texas Instruments (TXN, news, msgs) and Microsoft. There are also a number of semiconductor companies, including Broadcom (BRCM, news, msgs), Microchip Technology (MCHP, news, msgs) and KLA-Tencor (KLAC, news, msgs).

Also, there is evidence that growth stocks tend to perform best as bond yields fall. This is because lower interest rates make long-term earnings more valuable. Growth stocks trading at a discount include railroad operators CSX (CSX, news, msgs) and Union Pacific (UNP, news, msgs), as well as engine producer Cummins (CMI, news, msgs).

If you don't want to pick and choose individual stocks, that's fine. Just be sure to increase your equity exposure. Otherwise, you risk missing out on what is shaping up to be the greatest stock-buying opportunity of a generation -- just as negative long-term stock returns heading into the late 1930s and 1970s set the stage for fantastic bull markets in the years that followed.

At the time of publication, Anthony Mirhaydari did not own shares of any company or fund mentioned in this column.

Be sure to check out Mirhaydari's advisory service, the Edge, which was launched this month. He can be contacted at

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Recent Articles by Anthony Mirhaydari

12/11/2010 11:23 AM
Epic Bull??? Mr. Mirhaydari, If you are so confident that the market is set for an epic run, how come you do not own any of the stocks that you mention?
11/03/2010 8:15 AM
Everytime I see a "title" of an article that doesn't make any sense...I open it up and find it's always tied to Anthony the young guy. Is he in the same economy as we are? I guess there's no substittute for experience.
10/23/2010 11:13 PM
I'll wait until the grimy horde has finished selling. Then I'll buy.
10/18/2010 7:45 AM

This PROPHET  will speak:


No hiring no comsumtion

No comsumtion no 30000 DOW

Nice an healthy Companies DOW will go up for SURE

When hiring people starts the DOW will acelerate upward

Let us pray that the govermente start building and developing things that will create PERMANENT jobs, eventually selling them to the people

The prophet has spoken




10/03/2010 2:27 PM

Young man, I already know the long-term direction of the market is UP (if you are an adult, check any chart going back as long as your birthdate).


However, this article adds nothing new for the investor, or even the trader.  It was a waste of my time.

10/03/2010 12:56 AM

I don’t visit MSN Money very much anymore; usually just on the weekends to read Bill Fleckenstein.


Shamefully, I must admit to being suckered in by little Anthony’s ludicrous byline “Get ready for an epic bull market”, which no doubt was his intention. (Seeking attention.)

I noticed that it also gained him an appearance on Kudlow.


Upon reading his blarney, I found myself wondering if maybe Anthony had taken the place of Jon Markman as the resident schizophrenic nutcase? So I checked him out. Sure enough, on his resume was a job with ‘Markman Capital Insight’…


It was not a complete waste of my time however; I thoroughly enjoyed reading the comments! By golly, I think you guys pretty much have the situation figured out! Good going!!



Just one point of substance, from Marketwatch:


The biggest lie about U.S. companies
Commentary: Healthy balance sheets? They owe $7.2 trillion, the most ever
American companies are not in robust financial shape. Federal Reserve data show that their debts have been rising, not falling. By some measures, they are now more leveraged than at any time since the Great Depression.
Central bank and Commerce Department data reveal that gross domestic debts of nonfinancial corporations now amount to 50% of GDP. That's a postwar record. In 1945, it was just 20%. Even at the credit-bubble peaks in the late 1980s and 2005-06, it was only around 45%.


See ya later...



10/01/2010 5:14 PM
The well articulated argument (essentially a form of market timing) for bond funds is interesting and should lead investors to investigate some bond fund investments.  But, why limit oneself to this class of funds?  There are tools that allow an investor to analyze all 20,000 funds available in the US.  Results from the tool available at can help investors compare any fund in context.  Funds are analyzed based on historic risk and return performance, and their persistence in beating the S&P 500 on both measurements.  Do look hard at bond funds, but look at the alternatives as well.  Make your decisions based on all the facts.
10/01/2010 8:41 AM

Keep your powder dry and your money safe.  As safe as it can be.







10/01/2010 5:53 AM

What are these "analysts" smoking? I'm dumb founded and befuddled when I read articles like this. What they don't get is that the last stock market boom was partly fueled by easy credit and ATM style home equity loans on inflated home prices. 25% of the people in the world, not just the US, are out of work. There are millions of homes being foreclosed on and a record number of banks going out of business every month. Banks aren't loaning money. How then are consumers going to match the spending levels we saw over the past 20 years resulting in high earnings and record stock prices? Wall Street has become a horse track where everything is driven by lies, rumors and rigged races, not business and economic fundamentals. Go back to the business school you graduated from and ask for your money back.

10/01/2010 1:50 AM

We should stop listening to the "experts" on CNN and just look at a few commonsense indicators and facts -  whose savings rate has increased? The RICH. What are the Vulture companies doing with all this bond money? Not investing and making products and creating jobs (unemployment still high), just inflating their "profits" and their stock price and sitting in savings. Is there still a problem with foreclosures? Still increasing but no one is saying that it is, all "solutions" so far have failed. Is health care for people denied insurance working?  No. Premiums are too damn expensive. Who gets the 5 billion that this portion of the program cost? Not the uninsured, as premiums are not subsidized, maybe the RICH. these uninsured will still be using the emergency rooms. What effect does the GMO food have on us? More people are getting sick but FDA/government impotent.  Middle class doing well? We barely have a middle class, the economic slaves are now losing everything, jobs, houses, cars, no jobs for college grads.


I will stop here, but we need to just look at the hard, cold facts, not what the VULTURES would like us to believe, so they can come in for the final kill!

10/01/2010 1:38 AM
gee Anthony... You got a lot bet on this or something?  You must be pretty desperate for this ploy to stir (potential) investors in the masses to open up trading accounts and pour the last of their money into the market.  Guess they can't rob the poor enough .  these guys want every last cent so they can go off to their rich hidaways.
9/30/2010 11:03 PM

All you doom and gloomers out there keep on listening to Rush and Fox News. Here in Texas the economy is like a horse ready to jump out of the gate. The problem is it's being held back by the rest of the you who are afraid to get your heads out of the sand and get back to rebuilding the economy. Get in gear or get out of the way.

9/30/2010 11:02 PM
Odd... Wasn't it last week or two weeks ago that I read here that some mathematical doomsday formula was in play and that we were almost likely to go into a Great Depression.

If anything, investor confidence is going sky high because they know the Republicans are going to kick out all the filthy Democrats and Obama's agenda will be haulted along with his "We will have Trillion dollar deficits as far as the eye can see, even if our economy returns to the way it was in 2007"

9/30/2010 10:56 PM
bosco115     bond prices cannot drop unless interest rates rise.  The Fed has been perfectly clear (from their words and past examples) that they are not going to raise interest rates anytime soon.

Ahhh, but the Fed doesn't set interest rates it can only influence them. There are many historical examples of when the bond market and the Fed have parted ways. Too much quantitative easing too fast could set it off, but an inflation scare is most likely going to be the causation. Also the time line is not right away, but eventually.



9/30/2010 10:14 PM
The stock market is a tool for the rich, too fleece the poor and do it legally.
9/30/2010 7:43 PM
Not quite yet. Let's see a pullback to the 1060 area on the S&P to shake out all those who bought on the "breakout".
9/30/2010 7:24 PM

The water's deep and smells really bad. Better keep your boats handy,and extra paddles too.

9/30/2010 7:15 PM
Stop loosing money get the market direction before you trade every monday and wednesday morning at www.matrixtradingclu​ and make winning trades every time. free trial so nothing to loose.
9/30/2010 6:51 PM

Read through the posts. A lot of opinions but didn't learn a thing.


So, get ready for some lessons, kiddies:


(1) All of that corporate debt issuance makes you wonder if Wall Street is going to make the same mistake with corporate and sovereign debt that they made with consumer debt. Is this the setup for the next blow up?


(2) So what the article is saying is that we need to re-inflate the market by pumping money into it (basically keeping rates low forcing people in)? Hmmm, that sounds familiar. Oh, yeh, they did that in 2002-2003 and look where that got us: inflated markets, no job growth and a financial crisis. Good thinking!


(3) What correlation between low rates and stock performance? Have you not been paying attention in the past 10 years? Bond rates kept on going down (even below the rates in 2002 which I thought we would never see again) and the market went nowhere in that time (except down).


(4) Let's try to get down to fundamentals. If your country is not educated/skilled; produces nothing but paper or financial instruments; has a bloated healthcare system that charges you for 10 versions of a drug when one will do (not to mention wastes enormous money marketing Viagra and denying you insurance coverage you paid for), you are always going to be hidebound in the global scene and dependent on others to live. How about companies actually spending that money they are hoarding re-training the work force to prepare them for the global competition (not to mention pay them what they earned in increasing productivity) or to hire more people so that money circulates in the economy and people can buy stocks with their own money instead of cheap leverage. How about using some of that money to fix the aging, rotting infrastructure? Don't you think that may produce a faster growing, more stable, more balanced and better economy?


9/30/2010 5:16 PM
 Disappointed How about those who no longer have a lot of money to make a lot of money to bet on the bull?I don't know. What's in it for us other than feeling sorry we were'nt rich to get richer?Sad
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