“We are going to have to address the debt. And we are going to get more debt.” – Joe Kalish, Chief Global Macro Strategist, Ned Davis Research
+ Low core inflation currently persists in the U.S. and around the world.
+ Interestingly or frustratingly (for those bearing the brunt), shelter (housing) is running at 3.25% but overall inflation is low (below 2%). NDR noted that if individuals are spending more on shelter, they have less left over to spend on other things. Thus overall low inflation.
+ In the U.S., the labor markets have tightened. Recruiting difficulty is high. Labor compensation is rising! That may lead to rising inflation pressures.
+ The Fed is underappreciating aging demographics.
+ Debt is high and a drag on growth.
+ Technology and globalization are both keeping prices down.
+ It may be two years before we see inflation pressures pick up.
+ Note in the following chart the bottom section showing the “Economy Above Potential – Inflationary.”
+ We should see inflation pick up when we get above the dotted line in the bottom section of the chart.
+ Bottom line: short-term cyclical pickup in inflation but no serious long-term secular inflationary risk at this time. I’ll post this chart for you from time to time:
+ Global growth remains steady.
+ Seeing broad breadth in Manufacturing Purchasing Managers Index – a strong reading leaves NDR to not worry about the economy for at least three to six months or perhaps through the balance of 2018.
+ Overall economic outlook is good.
+ There is little chance of recession in the next six to nine months.
+ Stocks are richly priced.
+ Haven’t had a 5% correction in over a year.
+ Global breadth and momentum are positive.
+ Stocks still look like a better value vs. bonds.
+ Seeing cyclically higher inflation, but a long-term secular inflation call is far away.
+ Not enough evidence to declare the bond bear market is here.
+ Technology and better information systems.
+ Asset allocation rebalancing – As time steps forward, target date funds must sell equities and rebalance to bonds…aging population and the popularity of target date funds. (SB here – interesting…forcing clients into more and more bond exposure at near zero interest rate returns… seems pretty risky to me).
+ Central Banks – QE and better communication. Noted was that central banks are buying securities you and I would never consider buying, such as negative yielding bonds.
+ Index Funds – All the money into passive index funds causes buying of every stock in the index. Reducing overall market volatility.
+ Bank regulations requiring higher capital and liquidity.
Note the yellow dot vs. the 1929 and 2007 market peaks.
The orange line marks the Tech bubble period.
We are 3/10ths of a percent from the 1929 valuation high.
Note the “We are Here” – Overvalued area.
Note few times since 1964 where the market was this much overvalued.
Take a look at the orange arrow and the yellow highlighted oval.
It shows just how far the market is priced above “median fair value” and the amount of decline it would take to get to that level.
I also like how it considers levels of both “Overvalued” and “Undervalued.”
Think of them as risk and return targets.
+ Returns are ranked by quintile. 1 is lowest incidences of median P/E, 5 are the highest incidences. Reported is the nominal (before factoring inflation) subsequent 10-year realized median returns by quintile.
+ They took each month-end median P/E and looked at the annualized return that occurred in the S&P 500 Index 10 years later.
+ Then they sorted the results into five quintiles and posted the median annualized return by quintile.
+ We currently sit in Quintile 5 today.
Data is from 1880 to present (source).
Note higher than 1929’s “Black Tuesday” and 1987’s “Black Monday.”
Note higher than any other time with the exception of the 2000 Tech bubble.
We sit high in the highest 20% of all monthly valuation numbers since 1880.
The chart details the returns that occurred 10 years after each month-end Shiller P/E reading. It then groups the numbers into five quintiles ranging from lowest P/Es to highest P/Es and shows the average annualized return after inflation based on each quintile.
Note the average P/E for each quintile is shown at the bottom of each blue bar.
Bottom line: you get much more return on your money when you buy low (valuations are most attractive) and least when you buy high (like today). Expect 2.3% real annualized returns over the coming 10 years (and likely a bumpy road on the way to those low returns).
Blue line tracks the percentage of household financial assets that are allocated to equities.
When investors are heavily weighted into stocks, much of the buying has been done.
Such periods of high stock ownership correlate with lower subsequent returns and low stock ownership correlates with higher subsequent returns.
As Sir John Templeton said, “The secret to my success is I buy when everyone else is selling and I sell when everyone else is buying.” This chart demonstrates that saying.
Note how the dotted black line (the plotting of the actual return over a rolling 10-year period) closely tracks the blue line… with a 0.91 correlation coefficient since 1951. In geek language, that’s a statistically significant correlation not to be ignored.
This chart says we should expect 1.25% annualized returns over the coming 10-years… before inflation. Not so good.
I added the red arrows for emphasis.
Forecasting -4.1% for equities and -1.0% for U.S. Bonds over the coming seven years.
Stay calm and read along… there are things you can do…
Simple conclusion, most metrics are “Extremely Overvalued.”
There have been several whipsaws in the last year (yellow circles).
Current down trend marked by red arrow.
This is a longer-term look at HY.
Best to avoid the big declines – this is where trend following can help.
Note the large decline in 2008 of -34% and the early 2009 decline of -18%.
A few bumps since in 2013 and 2015, but new highs since.
Yields in 2008 pre-correction touched 7.5%. Last recession is highlighted in grey.
In late 2008, prices crashed and yields shot up to 23%.
The current yield is 5.7%.
Today, credit quality and investor protection (bond covenants) has never been worse.
We will see record defaults in the next recession.
I’m looking for yields north of 25%.
The system has never been more leveraged.
Just saying… be careful.
PD1: Un escultor amigo mío se ha metido en una campaña de crowdfunding para sacar dinero para unos niños en China que necesitan un hogar. Es un proyecto muy bonito del que pueden salir muchas cosas. Ofrece a cambio una escultura de la imagen de la Virgen embarazada, Señora de la Paz, rezando:
Te copio el link de la campaña por si te interesa: https://www.kickstarter.com/projects/ladyofpeace/lady-of-peace-senora-de-la-paz-javier-viver?ref=user_menu Gracias.