Paulsen: Secular Bull May Be Coming — if Inflation Held in Check

Wells Capital Management’s James Paulsen says that we are in the early stages of a “robust economic recovery”, and that it is a “reasonable possibility” that the S&P 500 rises about 25% higher than its current level at some point in 2010.

Paulsen tells Barron’s that he thinks a variety of factors will boost the economy, several of which have to do with the government. Annualized monetary growth has been about 10% since Lehman Brothers’ collapse, he says, short-term interest rates are effectively zero, and long-term interest rates are near postwar lows. In addition, the dollar and oil prices have fallen significantly, which provides a boost, and corporations “are sized as if depression could ensue any day. They’ve purged payrolls, lopped off underperforming operations, cut costs, slashed inventories, held back on capital spending and boosted productivity,” Paulsen says. He thinks that as sales rebound, profits will thus soar.

In terms of the stock market, Paulsen says it is likely that we’re early, not late, in the bull market.

Investor psychology is bad, which is a positive for stocks, he says, and liquid-asset holdings of households and businesses are at a record high relative to GDP. “This money is likely to act as a slow-release Tylenol tablet over the next several years, leeching into the market and driving stock prices higher,” he says. Low core inflation and accelerating global growth are also bullish signs. And, Paulsen says that the extremely low interest rates and low inflation make stock valuations — the S&P 500 is selling for 13.5 expected 2010 earnings — very attractive.

Paulsen says he sees one of two possible scenarios playing out for stocks. One is the development of a prolonged secular bull market — if inflation is held in check as the recovery progresses. Paulsen says there’s a “better than even chance” of that scenario occurring. The other possibility is that there will be a strong recovery and  surge in corporate earnings, sending stocks toward their all-time highs — and leading to major inflation. “Then the Fed would be compelled to raise interest rates, and that, in turn, would choke off the recovery,” he says. “The result would be a trading-range market with the new highs setting the upper band for stock prices.”

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