Global Assets in a Synchronized Bubble
by the Curmudgeon with Victor Sperandeo
Is All the World in a Bubble?
Has the main stream media FINALLY gotten the message? What Victor and I have been writing about for what seems like eternity?
"From Stocks to Farmland, All's Booming, or Bubbling" screamed the NY Times front page lead story on July 8th (today). The article calls attention to assets of all kinds-from stocks to bonds to real estate to art- that are historically overpriced (even more so when considering the weak global economy).
Around the world, nearly every asset class is expensive by historical standards. Stocks and bonds; emerging markets and advanced economies; urban office towers and Iowa farmland; you name it, and it is trading at prices that are high by historical standards relative to fundamentals. The inverse of that are relatively low returns for investors."
“We’re in a world where there are very few unambiguously cheap assets,” said Russ Koesterich, chief investment strategist at BlackRock, one of the world’s biggest asset managers. "“If you ask me to give you the one big bargain out there, I’m not sure there is one," he added.
We found three assets to be especially overpriced- Spanish Bonds, French Junk Bonds, and U.S. Office space/real estate. Let's examine each one of those asset classes.
1. In Spain, where there was a debt crisis just two years ago, investors are so eager to buy the government’s bonds that they recently accepted the lowest interest rates since 1789. In June 2014, Spain's 10 year government bond yielded less than the comparable 10 year Treasury note. Today, it's a bit higher with a yield of 2.72%. You can view a YTD yield chart here.
2. In France, a cable-television company named Numericable was recently able to borrow $11 billion, the largest junk bond deal on record — and despite the risk usually associated with junk bonds, the interest rate was a low 4.87%.
3. Office space in central business districts nationwide costs $300 per square foot on average, up from $147 in early 2010, according to Real Capital Analytics. In New York, the Art Deco office tower at One Wall Street sold in May for $585 million, only three months after the going wisdom in the real estate industry was that it would sell for more like $466 million, according to www.realert.com.
The referenced NY Times article notes that The Everything Boom brings obvious economic risks, including busts in one or more markets that could create a new wave of economic ripples in a fragile world economy still not fully recovered from the last financial crisis.
The article cites two principal reasons for inflated asset prices:
1. Global central banks easy or free money policies (which Victor and I have pounded the table about for the last two years). “Interest rates are so low,” said Peter J. Clare, a managing director and co-head of the United States buyout group at private equity firm the Carlyle Group. “There are few other attractive places where investors can direct their money, so it drives investor money into equity markets. It’s just the most basic of supply and demand equations: When there’s more demand, it drives up the price and pushes valuations where they are today.”
2. Business and other entities unwilling to make capital investments, hire more workers, etc. for fear that a weak economy won't give them a decent return on such investments. "There is simply too much savings floating around relative to the desire or ability of businesses and others to invest that savings productively," Neil Irwin, the NY Times author wrote.
The NY Times article quoted x-Fed Chair Ben Bernanke, now at the Brookings Institute: “It’s entirely possible that if you look at the world, you have slow-growing advanced economies, China cutting back on capital investments, the rate of return is just going to be low.”
Could that be the reason that U.S. corporations use their $1.5 Trillion cash hoard to buy back stock instead of making productive investments in their companies? That would help the real economy, but no one seems to care about that!
In the first quarter of 2014, S&P 500 companies purchased $154.5 billion worth of their shares back (via stock buyback programs). Over the trailing 12 months, S&P 500 companies have purchased more than half-a-trillion dollars’ worth of their own shares — $535.2 billion to be exact. (Source: FactSet, June 18, 2014.) As we've repeatedly noted, share buybacks increase earnings per share, reduce the supply of stock, and provide cash to the sellers of the company stock to invest in other publicly traded companies.
Another way companies reduce costs is by layoffs, replacing men with machines and shifting full time employees to part time status. Last Thursday's BLS jobs report stated that there were 840,000 workers shifted into “part time” status in June That was nearly triple the number of new (part time) jobs added. A large number of workers have their hours cut from full time status to part time status has a negative effect on consumer incomes and their ability to buy products and/or services.
The Correction Free U.S. Stock Market:
The S&P 500 chart below, courtesy of Adviser Perspectives, depicts the huge 193.5% up move since the March 2009 bottom and notes four corrections of 7.7% to 19.4% along the way. According to Bespoke, it's been well over 1000 days since the last 10% correction ended in early October 2011 (the 19.4% decline depicted in the above chart). Let's look what two Wall Street analysts have to say about the current state of the U.S. stock market.
In a July 7th commentary, Raymond James Investment Analyst Jeffrey Saut wrote:
"I am making a “call” that the current set-up in the equity market is remarkably similar to the summer of 2011 that ushered in an 18% decline. While I do not think any pullback from here will be that severe, I do think we are vulnerable to a 10% - 12% decline in the weeks ahead, albeit within the construct of a secular bull market that has years left to run."
On volatility bottoming, Mr. Saut wrote:
"Last week the Volatility Index (VIX) tagged 10.34 on an intraday basis for its lowest reading since late 2006 and early 2007......If past is prelude, that 10.34 “print” should be THE low water mark for the VIX with an ensuing pickup in volatility in the weeks/months ahead. Manifestly, “Periods of extremely low volatility tend to be followed by periods of higher volatility.” What this means for the equity markets is debatable and depends (IMO) on whether the SPX can stabilize above the 1940 – 1950 support level so often mentioned in these comments."
We do respect Mr. Saut who was the ONLY market analyst we know of that called the stock market bottom in March of 2009 (The Curmudgeon thought the bear market had a lot further to go and was waiting for a test of the lows which never came). Jeffrey is not a perma-bull, like Laslo Birinyi (calling for S&P 2100 this year) and so many other noted market technicians/ analysts.
Citi's Chief U.S. Equity Strategist Tobias Levkovich is bullish and believes in riding out any market corrections. In a July 8th investment strategynote to private clients he wrote:
"The S&P 500 has performed admirably and now has risen for more than five years without a bear market. When considering the length of the upward trade without a 20% correction, some might suggest that the bull is getting old and thus investors are likely to witness an overdue substantial pullback. However, such thinking implies that record earnings, significant stock buyback activity and unprecedented global central bank easing has no impact either and that some rallies can last longer than traditional averages."
However, he states that a correction could begin anytime, but advises against selling into it.
“Many investors wonder if the ride is over. As stock indices hit new highs, there are those that fear further gains, given defensive positioning, but more worry about buying in now just in time for a severe pullback....It is fair to suggest that at some point in time there will be an event that causes a much more meaningful decline in broad indices but it may not derail the overarching bull thesis. There is little doubt that 1982-2000 provided investors with a historic run in stock prices, but there were very rocky bumps along the way and such developments could occur again; nonetheless, the buy and hold strategy had merit then and does so again."
Victor's Comments on the Aging Bull Market1:
Ignoring age and time in humans or markets is Irrational. Let's define our terms to explain why. In the three trends that operate in any market at all times (the short, intermediate, and long term), the one that is currently at issue is the "intermediate trend." That trend is usually measured from weeks to months.
Note 1. Victor's original comments on this topic were in 1991 in his interview with Jack Schwager in the book: New Market Wizards.
Outlier statistics (a 3 standard deviation event) may be rare, but it exists in almost everything. The oldest woman in the USA today is 116, while the average life expectancy for women (as of November 2013) is only 81.
Markets can also have significant statistical meaning in time or age when measuring risk and reward - most of the time. However, it is not to be misused as a crystal ball. When you have an old versus young intermediate move it is more prone to end. The whole (very profitable) life insurance industry is based on these actuary concepts.
This market's intermediate trend age is very old indeed. By my count, the up move started on Nov. 15, 2012 (on the S&P 500) and is now 595 days old to the high of July 3, 2014. The up move started at the intermediate low of Nov. 15, 2012 based on "Dow Theory classifications." This method, in place since the 10th of August 1896, forms the statistical analysis of the markets actuarial base that I have used with great success since 1970.
[William Peter Hamilton (the 4th editor of the Wall Street Journal from 1902-1929) wrote 255 editorials on Dow Theory and classified the movements. His famous book, "The Stock Market Barometer" is a classic and explains a great deal of the insights on market movements using the theory.]
Over 118 years, the stock market declines as a pure percentage -measured from the top of the move- or - as a percentage of the previous advance (i.e. 1/3 to 2/3 of the advance)- take into account 88% of all the "corrections" that are at least 10%.
If one used the 10% example of a decline as the definition of a "correction," one would count days from Oct 3, 2011 since a >10% correction took place. If so, that would make the current up move another 408 days old for a total duration of 1003 days! [That number was attributed to Bespoke and quoted by USA Today].
In Dow Theory terms this is the fourth longest move without a correction in 118 years (but there's nothing magic about 10% in Dow Theory).
Let me mention Robert Rhea, the greatest a Dow Theory analyst ever. He wrote several books on the subject. The best was simply called "The Dow Theory." In the 1970's, I managed to obtain his excellent "Dow Theory Comments" or market letters, which were published approximately every 14 days in the 1930's. Rhea called the markets to perfection from 1932 to his death in 1939.
In conclusion, we have a very old trend in the stock market, poor economic fundamentals, with fair to high valuation. Certainly, the extended intermediate move can continue further, but the assumption it will (optimism) ignores risk which has greatly increased with the age of the intermediate trend.
Think of today's market as a very old man who has a bad cold, nagging cough and fever that might turn into pneumonia. As I've mentioned previously, any unexpected event could kill this very old man (i.e. the market's uptrend). However if risk is not an issue and you believe in "Goddess Janet" then by all means buy- em and bid- em!!!
Even if you are a believer in Yellen, note that after 5 years of ZIRP and QE's, Operation Twists, etc. there are no bullets left in the Fed's gun -all the ammunition is gone, except possibly a QE 4 that buys stocks instead of bonds and mortgages? We'll see how it all plays out.
Till next time........................
Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
Copyright © 2014 by The Curmudgeon and Marc Sexton. All rights reserved.
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