The stock market has been holding close to last week’s record highs despite some consolidation this week. Markets are keeping an eye on Japan’s new stimulus plan, as well as, the Fed’s ever so slightly more hawkish view. With the market refusing to turn meaningfully downward, more and more indicators are pointing to continued strength even if there is a small pullback short-term. We have been fully, to nearly, fully invested recently.
Ned Davis, one of our key research partners, points out that investors are paying a premium for investments and that “we’re now seeing Return On Invested Capital (ROIC) for non-financial corporations consistent with levels we have historically seen in economic recessions.” Davis is not suggesting that we are in recession territory just yet, however notes that “investors are paying a premium for low ROIC.”
This suggests that while near-term conditions are supportive of a continued rally in the stock market, even if a very short-term pullback appears possible (more on that in a minute), that investors are clearly in on the TINA THERE IS NO ALTERNATIVE approach to investing in the stock market due to ZIRP (Zero Interest Rate Policy) and NIRP (Negative Interest Rate Policy).
As noted last week, investor sentiment has been fairly neutral, neither reaching optimistic nor pessimistic extremes which would signal a change of market direction. The lack of fear is supporting the rally in global equity markets since Brexit. A lack of irrational exuberance amongst investors is preventing the turn down bears have called for in the past several years.
Thomas Lee of Fundstrat Global Advisors, has been a long-term bull on the U.S. stock market by repeatedly noting that fundamentals underlying the U.S. economy continue to slowly get better. This fundamental improvement has been the match that U.S. stocks have used to put flame to the tinder which the Federal Reserve has provided.
In a recent CNBC interview, Lee stated his concerns for the month of August; noting that historically August has been a tough month for the S&P 500 with a average losses of 6% the past nine years.
Lee also pointed out that the bond market is sending a short-term warning sign, “”the bond market has become a lot more volatile than equities, and whenever this happens, 68 percent of the time, the stock market falls in the following month.” He followed up by suggesting that investors should buy any correction on anticipation of a rally later in the year.
Lee’s expectation of a continued rally after a small pullback is also supported by bullish signals at Howard Capital Management (one of our investment platform managers). Like Lee, Howard notes that on the “short-term basis markets are a bit stretched and a normal pullback could be warranted.” HCM states that “any pullback should be seen as a buying opportunity.”
From a tactical perspective, the ratios governing our allocation tilts favor U.S. equities over Foreign equities. Both Developed International and Emerging Markets, are less than 10% away from us committing to an allocation. Gold, silver and precious metals miners have been in favor since late last year and we are over-weighted in these areas. Relative strength in other commodities hasn’t picked up enough for us to commit to an allocation. The commodity index is tightly correlated to the US dollar and with the Fed on a slight tightening bias, we would need to see the complex rise by at least 10% before committing an allocation.
With over 30% of sovereign debt in negative yield territory, global investors are in the hunt for yield. Within the Global Macro bond space, 10-year treasuries, high yields and investment-grade bonds are market leaders. In the international space, emerging market debt has been the clear leader.
For investors willing to move out further onto the risk spectrum for yield; MLPs, US preferred stocks and high dividend large-caps have seen price momentum. Value managers have had a nice run due to risk-free assets paying almost nothing, or worse, receiving long-term guaranteed losses due to negative interest rates. The only logical explanation for the insanity of investors willing to buy negative yielding debt, is they are willing to pay for the explicit government guarantee to return capital after interest costs.
As always, Global View will be seeking to understand the underlying fundamentals of the markets while keeping up with the changes that impact price direction of investments. By doing this we can protect ourselves from developing risks while participating in many of the opportunities.