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Terror, debt and valuation

Brouwer & JanachowskiMarch 24, 2016

The market took a rest this week. Some of it was pure exhaustion from last week’s data. Some of it was positioning, and trader absenteeism ahead of the Easter break in most countries. And some was shock at the horrific actions in Brussels. As of Thursday’s close, the market broke its fifth straight week of gains to close more or less flat. Still, that's up around 10% from February lows and other markets, for example U.S. Small Cap and Emerging Markets, up by even more.

Action in the bond markets was around a safety trade. Any political or terror event leads to aspike in U.S. Treasures. But then some Fed Governors contradicted last week’s FOMC meeting, saying, “No we may want more rate hikes this year”. Pity Janet Yellen. You work hard for consensus and then Governors go rogue and say the complete opposite. The Ten-Year note finished at 1.89% towards the lower end of its YTD trading range. Here’s what caught our eye:

  1. Emerging Markets: one of our calls for the year. The Bank for International Settlements (BIS) issued a report on Emerging Markets debt, posing the question “are they borrowing too much and do they have a mismatch?”. The short answer was “sort of” and “yes”.

Here’s the first chart showing the growth in debt to a level on a par with advanced economies. So far so ok. There are nuances on debt issuance like can you afford it and where’s it going?

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We’ll leave aside where it’s going for another post. But here’s the “can they afford it” bit.

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This measures debt service coverage and the number is surprisingly low. It’s one reason why we didn't like Emerging Market debt coming into 2016 and prefer equity investments.  It offers more selectivity and potential upside.

  1. Stock Market Valuations: there’s plenty of debate about the right way to measure stock market valuations. We like the old but reliable ones like dividends and price earnings multiples. But we saw this week an interesting take on the CAPE, which values stocks on a ten-year cycle. Researchers at GMO took a look at what influence the Fed, and particularly the days of a FOMC meeting, had on the market. It’s a lot. Our take away is that the market may be cheaper than it looks because of increased market support by the Fed. The big question, of course, is will they continue to do so. Probably.
  1. Energy: slipped a little this week. There’s much going on from increased gasoline demand, to excess inventories, big ethanol, over capacity and a lot of short covering if the woes of hedge funds are anything to go by. The market is following it closely.

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It's the U.S. stock market against oil and for now we’re in oil-led market.

Bottom Line: We would like to see a consolidation phase. They seldom come as calm sideways markets. More like bunny hops. But we’re confortable with our call on domestic equities and the inflation hedge in TIPS. Have a great weekend.


All ETFs are not created equal and can close abruptly

World leaders and awkward handshakes

Internet connection speeds in the U.S.

Victims of terrorist attacks in Europe

Trouble in the land of unicorns

--Christian Thwaites, Brouwer & Janachowski, LLC


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