The Week Ahead: Still on top. Been a quiet week.
We made it. In 1999, the S&P 500, Dow Jones Industrials and NASDAQ indices all peaked at the same time. It took 17 years but this week they peaked it again. Here’s the chart. But we threw in the Nikkei 225 for good measure to remind ourselves that not all markets enjoyed the ride.
We would not spend much time with the Dow or NASDAQ. We use neither for portfolio construction. The Nikkei is another story. The long slow bleed in Japan has only recently turned. The market looks interesting from a yield opportunity but we have time.
So, with market tops around, here’s the question:
Are markets expensive? No. There are many ways to look at market valuations. None are infallible. But here’s one way to look at it.
This is the U.S. Treasury Ten-Year yield less the yield on the S&P 500. Perhaps over simply, bonds yield more than stocks in inflationary times to compensate for the erosion of value in a fixed income investment. This was the case for about 50 years until 2009. That’s the blue line well below the yellowish line.
Since then stocks yielded more than bonds in 2009, 2013 and 2015. That’s the “Yield Gap” line below zero. In each case, markets subsequently rallied. Right now, stocks yield 62bps more than bonds. On this measure, stocks look reasonably priced against bonds. On other measures, like price earnings, book value and earnings growth, valuations are high but not excessive.
The U.S. Economy: Productivity fell 0.5% in the second quarter. And unit labor costs rose 1.9%. One quarter doesn't matter much. But here’s the long view.
There has been lots of bad commentary on this…one very good book and some excellent papers. This is our take. Productivity growth, or the amount of labor required to produce a unit of output, is chronically low. And it’s low at a time of so-called full employment. Now, some blame the rise of temporary labor (two baristas working 4 hours a day sell no more coffee than one working all day), some technology (your Android may make you more productive at home but not at work), or that labor is cheaper than capital and so companies need not compete on efficiency in output.
It’s a puzzle and we don't pretend to have the answer. For us as investors, we need to look at company costs and margins. They are holding up for now. But don't expect much consumer spending growth if we continue to see numbers like these. The other thing to look for is inflation. Costs up and productivity down usually mean price pressure.
Bottom Line: News will dwindle over the next few weeks. Earnings season is over. The next big event is the annual central bankers’ retreat at Jackson Hole…think Davos for bankers. Some important policy decisions have come out of there in the in the past. We think Chair Yellen will talk about holding rates but data dependent etc…(Fed speeches haven’t changed much in the last 9 months).
Families spend more on healthcare than food.
UBS promo vid in super slo-mo
Palo Alto’s housing problem
It pays to be grumpy
The media is a lousy market predictor
--Christian Thwaites, Brouwer & Janachowski, LLC
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