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Too Many Highs

U.S. Stocks continued their drive to record highs. They have recovered all their post-Brexit correction. The broad U.S. market is up 7.1% this year. Small and Mid Caps are up about 10%. So all good? Well, not everywhere. Most European markets have had a torrid year, ranging from down 20% for Italy to down 5% for Germany. The UK stands out. It’s up around 7%. But for U.S. investors it’s down 5% after the thrashing the pound sterling took in the aftermath of the vote. And Asia and emerging markets? Mostly down with a few exceptions. India, for example, is up around 7%.

We see the world in three main ways:

  • When you have low rates, stocks look good: Yields are low, with no respite. This creates a valuation dilemma for stocks, which we discussed in last week’s post. Investors are choosing to drive stocks higher based on a simple valuation. Here’s the chart:
blog72016Forward PEs_SP50-USA
blog72016Forward PEs_SP50-USA

The top line is the S&P 500. Record highs. But it’s the next line that interests us. Earnings per share on the S&P 500 are slowly recovering from the "earnings recession” we had last year. And at the bottom, the Price/Earnings multiple for one year ahead are at 16, which are at the top end of the range, but then bond yields have never been this low. Hence, stocks look attractive. They yield just under 2% and dividends increased 8% in the last year.

  • International: the major headwinds are ineffectual QE from the European Central Bank (ECB) and Bank of Japan (BoJ), and low growth. The major issue has been the state of the banks, where low yields have cruelly exposed capital inadequacy and poor lending. And of course the Brexit impasse. The EU has no clear idea of what happens next. Woeful leadership compounds uncertainty. Stocks are not expensive, but margins, sales, earnings and dividend growth are all about three points below the U.S.
  • U.S. Treasuries: the theme of the year. Rates on the 10-Year have risen 20bps (.20%) since the July lows but remain 90bps (.90%) below when the Fed last hiked. Most U.S. economic data is in flux. Not enough to warrant an increase. But even if we’re stuck in the 2% growth rut, we argue that the ECB, Bank of England (BoE) and Bank of Japan (BoJ), have tied the Fed’s hands and repriced sovereign yields to a much lower environment. There’s some spillover into equities too:

This shows the high quality growth-dividend stocks in the S&P 500. They have done well and even when bonds correct, offer protection value. We recently moved clients into these stocks.

Bottom Line: We’re still early in earnings season. We see a positive tone and the outlook of around 5% earnings will be much better than the near 10% fall we saw in 2015. But we’re not in full “risk on” mode. Expect some correction days.


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--Christian Thwaites, Brouwer & Janachowski, LLC

Please note that the discussion of the investments and investment strategy of Brouwer & Janachowski, LLC (“Advisor”) (including Advisor’s research and investment process) represent the investments and investment strategy of Advisor at the date of this commentary, and are subject to change without notice.  Advisor cannot assure that the type of investments mentioned in this commentary will outperform any other investment strategy in the future, nor can it guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. 

References to an individual security should not be construed as a recommendation to buy or sell that security.  In addition, the securities noted in this presentation are only several of the successful as well as unsuccessful investments by Advisor, and do not represent all of the securities Advisor has purchased, sold or recommended. 

Advisor cannot guarantee the accuracy or completeness of any statements or numerical data in this commentary.  Past performance is no indication of future results.