A fiend of mine hit me on Facebook with this article to ask “What say you, Sensei?” While I certainly do not fancy myself a sensei, I do have some thoughts…
The article opens with this thought; “More than 80% of chief financial officers surveyed by accounting firm Deloitte said U.S. stock markets are overvalued, marking the highest level since Deloitte began conducting its quarterly poll about eight years ago.” It may be no coincidence that the markets are higher than they have been in the past 8 years of Deloitte’s polling…
Is the market overvalued? By many metrics, yes. The Shiller P/E ratio, for instance, currently sits around 31 which is almost twice its mean/average of 16. That means we’re paying double for each dollar of earnings in the stock market – higher risk with less reward to a certain extent. But a Bubble??? I’m not so sure… Neither is Mr. Shiller.
It’s easy to see why these CFOs might be saying the market is overvalued. It’s a hell of a lot easier to predict downtown rather than upturn after you’ve seen the market top over 40 new highs in 2017. It’s like flipping a coin and hitting “heads” 40 times in a row and then thinking you’re going to look like a genius by saying “I feel a ‘tails’ coming any flip now…”
I might ask though, if the market is so overvalued (or “bubblicious”), why do companies continue stock buybacks at a near record pace? S&P 500 companies spent roughly $120 billion on stock repurchases in the second three months of 2017. Though that pace is slowing a little, it still points to companies re-investing in themselves (buying their own stock) at a historically high rate.
What are the catalysts for the “bubblicious” bubble to burst?
- North Korea – if ‘Rocketman’ pops a hydrogen bomb over the Pacific Ocean, prepare for a huge dip in equities and a flight to safe havens (treasuries & gold).
- Unwinding the Fed – as the Fed begins unwinding is QE-infused balance sheet next month, keep a keen eye on the markets. Unloading $4 Trillion in freshly printed money has never been done before.
Any catalysts working in our favor?
The most sensitive Treasury note to Fed policy shifts is the 2-year note, and it is tapping its highest yield (over 1.4%) since November 2008. Higher rates on the 2-year note have a positive correlation with S&P 500 over the intermediate term. The 10-year Treasury note yield sits at 2.278% and 30-year at 2.808%. Nothing of concern there like the 2-year yield being higher than the 10-year yield – that would be concerning…
The S&P 500 yield is still hovering just below 2% which is below the 10-year Treasury @ 2.3%. Why is this significant? Before 2008/2009 crisis, 10-Year Treasuries (bonds) almost always yielded more than the S&P 500’s (stocks) dividend yield. In the QE era, however, the S&P’s dividend has crossed above the yield on the 10-Year Treasuries many times. To fuel re-investment into the stock market, the Fed sought to make “risky” assets (stocks) attractive in relation to “risk-free” rates (bonds). That is a huge part of the stock market’s record run since 2009 – and huge part of why that policy made the rich even richer despite those making the policy criticizing the fact that the rich are getting richer – but I digress… #facepalm
When the S&P’s dividend yield rises above the yield on the 10-Year, I see that as a market anomaly. Currently the 10-year Treasury yield, sitting at its highest point since Aug. 2, and still riding a 1/2 point above the S&P 500. If the 10-year T-bill continues to rise higher against the S&P yield, that could cool the stock market down a bit.
Yields are also climbing as it appears to be a “done deal” that the Fed will raise interest rates in December with inflation running under their 2% target. Since yields are inverse to the price of bonds, that will push bond prices down further. Normally when bond prices fall it means stocks are moving higher. Normally… Historically, there has been an inverse correlation between the movement of stock prices and the prices of bonds – but then there is that Fed Balance Sheet again, and with ZIRP and QE…
The VIX is a volatility index and often referred to as “The Fear Index”. It is tied to options on the S&P 500 and a gauge of trader expectations for the range of prices they expect the S&P 500 to trade over the coming month.
What does it show? The VIX is trading on record lows below 10 with no signs of moving upward in a rapid fashion. Aside from 3 quick spikes this year, it’s been trending downward in 2017. It’s currently down over 32% on the year. In fact, shorting the VIX (selling volatility – see chart above) is considered one of the hottest trades in the market today – this means traders are betting on peace & calm in the markets…
Yes, the market is high, and by some metrics overvalued. Yes, the market will probably see a bit of slow-down, dip, drop, correction – whatever you may want to perceive it as. Is there a catalyst for a bubble to burst? I don’t see it myself. Certainly nothing like we saw in 08/09.
I’m far more concerned about earning below average returns over the next several years. The longterm S&P 500 average is 11.1%. Can we eek that out over the next decade as interest rates rise, QE ends, the FED unwinds, and the dollar threatens a retreat? With the market this high returns may slow a bit…
Get & stay properly allocated. An 80/20 or 70/30 mix of stock to bonds is a good place to be. Have some gold in there at around 5% of your total portfolio too if you like the shiny stuff (I do…).
Where can you go to make money in an “overvalued market”? Commodities are cheap right now as the dollar remains strong, but that could change as the Fed begins unwinding and interest rates rise. If the dollar begins to lose ground, commodities are going to rise. (If you like trading commodities, check this guy out!)
The WOOD (timber & forestry) ETF is up around 10% since I wrote about it here. BNO (Brent Crude Oil ETF) is up 10% as well since I mentioned it in the same article. Those buys felt like easy money to me given market conditions and news events – turns out I was dead-on and I’ve made an easy 10% so far.
There are some emerging markets offering some value in small cap companies right now. Those investments will carry some unique risks in terms of volatility and currency risks, but they do seem like good long terms buys to me right now. I plan to write about them soon…
I like the S&P Completion Index. ETFs that track the S&P 500 are by far the most popular investment vehicles today. The completion index basically holds every liquid stock not in the S&P 500. Combined with an S&P 500 index, holding the Completion Index would give you total stock market exposure. On its own, the Completion Index would expose you to stocks that aren’t in most everyone else’s portfolio. It’s outperforming the S&P 500 this year and I’m interested to see how it performs in a down market when everyone will all be selling the same stocks in the popular S&P 500 ETFs.
That’s the news as I see it – as always, do your due diligence and consult the services of a reputable, fee-based, licensed advisor as necessary. Cheers!