This Week: Friday's the day
Stocks gave up a little ground last week. At one point, they were down 1%. They rallied to remain largely unchanged. There is not a lot of news, and what there is, is often amplified. The dollar came under some pressure. Ten-year Treasuries traded in the 1.50% to 1.58% range.
So, with market tops around, here’s the question:
Are markets expensive? Part 2: We answered last week “No” based on the yield gap. Now there’s no infallible valuation guide. There are some good long term ones. The Cyclically Adjusted Index from Robert Shiller is excellent but not a direct guide to the markets. There are a handful of ETFs that track it. All have unexceptional performance. Tobin’s Q is also excellent but uses lagging data. So here’s one we look at:
This is for small cap stocks. Most of the numbers are above the long-term averages (except for Cash Flow) but not alarmingly so. Also, markets tend to look expensive ahead of recoveries. We expect a rebound in earnings later in the year, for the simple reason that the year on year comparisons will be easier. So, put these all together and stocks look reasonably priced. There may, of course, may be some political noise.
The Fed. We wonder whether anyone can control the Fed. It looks like this. Last Monday, we saw a very reasoned piece from San Francisco Federal Reserve President John Williams on the low natural, or inflation adjusted, rate of interest and the low growth economy. Later in the week, he said waiting to increase rates could be “costly”. Eh?
The Fed Minutes came out and serial dissenter Esther George said that we should all raise rates that are consistent with “several frameworks”. Eh? Is that the framework that keeps inflation below target, financial markets nervous and rates at all time lows? If so, we’ll pass.
But that’s not all. St Louis Federal Reserve President James Bullard then said that the low growth/low inflation regime might last another two years.
On the back of all this, we'd say the market ignores the Fed when it doesn't fit the agenda. And the agenda is about a market where, if the Fed increases rates in a low rate world (where Ireland, Italy and Spain all borrow cheaper than the U.S.), a rate hike would ramp up the dollar. Which adds deflationary risk.
Energy: Last week Oil rallied. It was back to where it was a month ago, a year ago, eight years ago and twelve years ago. Some of this may be a result of lower natural gas stocks and a closing of the normal gas/oil differential. But High Yield investors seem not to care.
If ever there was a “hunt for yield” chart- here it is. Investors have taken High Yield junk spreads down to levels below a year ago. During that time, downgrades increased, credit conditions worsened and 40% of the bonds in the index carry the lowest possible ratings. Hope it works out for them but chasing down the credit ladder rarely works.
Bottom Line: Friday Chair Yellen will give a speech at Jackson Hole. We think it will be non-committal. As it should be. Meanwhile stocks will settle into a narrow trading band. We’re making no major changes to portfolios.
Bottom, bottom line: On August 31st the S&P 500 will add an eleventh industry sector. Real Estate will become its own sector and split off from Financials. The Financial weighting in the S&P 500 will drop to around 12% and Real Estate will become 3%. This could lead some investors to rebalance their portfolios. We think this will be good for the sector.
The great productivity puzzle.
--Christian Thwaites, Brouwer & Janachowski, LLC
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