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Market Perspective for 6/28/19

The S&P 500 is up close to 4% since the last Update and about 6.5% since the June 3rd low.[1]  And yet, nothing really seems different in terms of the economy or the trade outlook.  We still have no resolution to the trade war with China, but much has been made of the fact that Trump might meet with Xi Jinping at which they might make a deal, which then might withstand public scrutiny when revealed, which then might actually be put into effect, which then might actually be adhered to by both sides.  Sorry for the snarkiness, but I believe we are a long way from a meaningful trade resolution.  What actually drove stock prices higher was the collapse of the growth narrative and the subsequent embrace of the multiple rate cuts narrative.  U.S. economic growth of 3% plus was a two-quarter anomaly caused by lower corporate taxes and the buildup of inventory ahead of the potential tariff hikes.  As the investment community adjusted to this and reduced GDP forecasts to 1.3%-2.3% growth for the next few quarters, interest rates collapsed.  Multiple Fed rate cuts have now been priced into stocks.  As you know, lower interest rates equate to lower discount rates which pushes the present value of stocks higher.   We expect the current rally in stocks to last only insofar as the confidence in future rate cuts lasts.

We lightened up on stocks in May as they approached and subsequently broke through some technical support levels. Depending on risk tolerance, some of the proceeds went to cash, but some also went to bonds and gold.  We did not increase stock positions during June as stocks rose.  Both bonds and gold have had nice runs this month, though both might be overbought in the short run.  As long as investors believe interest rate cuts are a when (as opposed to an if), it’s going to be hard not to make money in bonds.  Gold benefits from the low and falling cost of carry[2] since it has no yield.

The IPO wave that we wrote about last month is still in our minds in terms of a late-in-the-cycle marker.  This bull market has flourished on very mild enthusiasm so far.  Bull markets tend to die when everybody gets euphoric. The economy is modestly weakening; that and low inflation keeps the wind firmly at the back of higher quality, dividend paying bonds and stocks. That is our emphasis today.

I have a chart in my office that shows investment metrics for the 20th century.  Because of the Great Depression, there was a period of over twenty years (ending in 1954) that U.S. stocks yielded more than U.S. government bonds.  In other words, companies had to offer investors high dividends to get them to buy their shares because stocks were looked at as being so much more risky than bonds.  The return over the 50 years from 1950 to 2000 for stocks compared to bonds is comically lopsided in favor of stocks[3].  I think about that today as I look at Europe, where government bonds yield essentially nothing (or in some cases less!) while the average stock dividend is over 3%.  At some point (don’t ask me when) I believe European investors will embrace stocks, if not for the growth prospects then for the simple fact of much more generous yields.  I think of Europe post-financial crisis as being in a Depression of sorts.  Maybe it takes them twenty years to rediscover equities like it took us last century.  I believe that buying European stocks now might just be like buying U.S. equities in say, 1948.

Investment Observations

  1. I am not necessarily recommending investing in India. I would just note that it is one of the most un-correlated investment markets you will find anywhere.  Seriously, price movements are as random as managed futures funds, no matter how good or bad the day is for the rest of the world.  IFN is the ETF, and WAINX  are Indian funds I keep an eye on.
  2. Not all FAANG stocks are crushing it. Alphabet (Google) is down -7.7% quarter to date (as of 6/25/19 market close).
  3. Vanguard Wellesley is a conservative stock funds is worth noting.  Strong relative performance, low expense ratio (0.23%) and low monthly Value-at-Risk (4.49%).
  4. If one is contemplating high yield bonds versus floating rate debt today, pick the former. Yield spreads have improved due to strength in government bonds, while capacity to refinance existing debt is modestly better.
  5. Doubleline is best known as a bond manager, but it’s Shiller Enhanced CAPE fund (DSEEX) is a large cap value/blend fund that has handily beaten the S&P 500 since inception (2013) at a similar risk and a 55 basis point expense ratio.
  6. Gold mining mutual funds are up over 16% this month on average. Bullion ETFs are up 8.8% as of June 25th market close.

 

[1] Through June 25th

[2] In other words, the cost to finance ownership.  When interest rates are very low, it is financially much easier to borrow to acquire a non-cash, non-interest bearing, flowing asset.

[3]  Despite an incredible run in bonds from 1982 to 1998 as inflation expectations gradually receded, stocks rose more than five hundredfold over those fifty years versus under fifteenfold for bonds (my calculations based on Ibbotson annual return data).

 

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