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Market Commentary

SEPTEMBER 2017

 

Well, it certainly hasn’t been boring over the recent weeks. Making investment decisions with the daily back and forth about missile launches, hydrogen bomb tests and the like certainly has its challenges. It is nearly impossible to price-in or predict market outcomes if these provocations should suddenly become real events. That being said, we are keeping a close eye on geopolitical happings, and yet, the market seems mostly unfazed. We did have some short-term volatility for the month, but we still hover near all-time highs. Watching this behavior, we are reminded of an old trader’s axiom, “Never bet on the end of the world, because if you are right, you can’t collect anyway.” In all, this seemed to describe the behavior of the financial markets this last month.

 

Economic data for the month were mixed as retail sales came in at +0.6%, nearly twice the expectation and included a revision higher from last month’s data. Industrial production also rose +0.2% and Gross Domestic Product was a strong +3.0%. Slightly less encouraging was the jobs report, adding just 156,000 jobs for the month. Overall, we are still looking at an economy that is growing nicely and we have not seen any data yet that would warn of an impending recession. Markets can still have nasty corrections without a recession, but a full-fledged bear market will almost always be accompanied by an economic recession.

 

We have written at length that the stock market remains very expensive with a Price/Earnings (P/E) ratio based on the last twelve months earnings of 24.55 compared to a long-term average of 15.67. In addition, the S&P 500 Index has an earnings yield of 4.07%, compared to a long-term average of 7.39%. These numbers may be elevated, but once again, we must recognize that money has to go somewhere. An earnings yield of 4.07% may be a fairly low level of earnings for the stock market, but compared to a 10-year U.S. Treasury bond that yields around 2.10%, it’s not so bad. This is the catch-22 of the financial markets right now. As central banks have lowered interest rates by purchasing bonds for the last nine years, they have created a situation that forced investors to buy stocks. This in turn forced stocks to become expensive and this is where we are.

 

Speaking of the bond market, one concern that has been popping up is the U.S. bond market yield curve. The chart below shows us the difference in interest rates between the 2-year U.S. Treasury bond and the 10-year U.S. Treasury bond. The idea is that if we expect long-term growth to accelerate, the interest rate on the longer-term bond should be higher. When the short-term rate becomes higher than the long-term rate, the bond market is essentially predicting a recession. Below we see that the bond market is not as excited about the economy as is the stock market.

 

 

Still, even with the warnings from the bond market and expensive fundamentals, we are reminded of yet another old trader’s axiom, “The market is never wrong.” Below we see the S&P 500 Index going back to 2012. No sign of a downtrend yet.

 

 

 


We would not fault those who wished to remain cautious, especially in the face of so much global uncertainty, but we would not advocate running away from a rising market just yet. There will be ample opportunity to reduce risk if the catalyst to start a downturn should arrive. Until then, as long as the economy keeps chugging along, the market most likely will as well.

 
 

 

 

 


Disclaimer: Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of securities. Investments involve risk and are not guaranteed.