Friday, October 17, 2014

The Inequality Trifecta by Mohamed A. El-Erian - Project Syndicate

The Inequality Trifecta by Mohamed A. El-Erian - Project Syndicate

What Markets Will... Krugman 10/16/14 NYT

From Economist's View: Thoughts on high priced textbooks

The article discusses the principle-agent problem and its application to the textbook market.  Knowing that many of my students are opting to not buy textbooks despite the potential that it might result in lower grades, I've been talking to publishers about price discounts and have been successful negotiating price discounts, especially for principles textbooks.

Thursday, October 9, 2014

Root for a Correction

by Matt Malick and Ben Atwater
Root for a Correction

In market parlance, the textbook definition of a correction is a drop of greater than 10%, but less than 20%.  Any fall of 20% or more is considered a bear market.

Commentators often talk about a correction as a healthy phenomenon.  But, when one happens, it feels terrible – like it is never going to end.

It has been so long since we have had a correction - April 29, 2011 through October 3, 2011, when the market fell just over 19% on a closing basis - we almost forget how torturous they really are.

Presently, the Standard and Poor’s 500 has declined, as of yesterday’s close, 3.77% from its recent all-time closing high on September 18th.  This is far from a correction, but painful enough, especially given the dramatic underperformance of small-cap (Russell 2000) and international equities (ACWX) relative to the S&P 500.

However, a correction can be beneficial as long as investors don’t panic and make poor decisions.  If we are in the process of one, it would serve to make valuations more reasonable, dampen investor sentiment and provide a potential catalyst for a move to new highs following a successful earnings season.

As we approach earnings season, analysts are expecting S&P 500 companies to earn $29.69 per share in third quarter profits, which would leave the S&P 500 with trailing twelve month earnings of $108.27.  If the market were to correct in the meantime and fall 10% from its closing high to 1810.22, the price-to-earnings ratio on the market would fall to 16.71.  Although this valuation is not dirt cheap, it is close to the long-term average P/E and highly attractive when we compare bonds, real estate and various other asset classes to stocks.

Furthermore, when the market falls, investors almost universally get more pessimistic about the prospects for future returns.  And sentiment is a contrarian indicator.  If a correction shakes some of the fickle money from the market, then the market’s foundation is stronger when it begins to rise again.

As you well know, we believe excess valuations and sentiment are generally the preconditions for a bear market and corrections help dampen both.

Finally, if the market does continue to fall here, then a positive earnings season could be a catalyst to spur the market to new highs.  After all, if earnings meet or exceed estimates, we will then have back-to-back quarters of 9%-plus earnings growth, a seemingly bullish happening.

Wednesday, July 23, 2014

UPDATE: All-Time Highs

by Matt Malick and Ben Atwater

The stock market has been on a tear lately and the Standard & Poor’s 500 Index is approaching the two-thousand mark.  The current bull market, which began on March 9, 2009, is both the fourth strongest and the fourth longest, rising nearly 194% in over five years.

If it seems like stocks are cracking new all-time highs on a weekly basis, well, they basically are.  Since reaching a new all-time peak on March 28, 2013, the S&P 500 has hit a new record on 21.4% of trading days – more than once a week, on average.

Since its inception in 1950, the S&P 500 has struck new all-time highs on just 6.8% of trading days. But, this long-term average includes weak markets where new highs are rarely eclipsed, such as the period from 2000 to 2013.

The roaring 90s offer an interesting point of comparison.  After attaining a new all-time peak on Valentine’s Day in 1995, the S&P 500 made new highs on 19.1% of trading days up until the tech bubble began to burst in March of 2000.  This frequency is in the ballpark of the current environment.  But, keep in mind, that equities hit new highs on almost a weekly basis for over five years, whereas the current run has lasted less than 16 months.

As the market continues its ascent, we are keeping a close eye on sentiment and valuations.  Thus far, even minor upticks in volatility have led to spikes in bearish sentiment, as measured by various survey data.  From an anecdotal perspective, the financial media, the investment industry and even clients still seem to view this market with a great deal of skepticism.  Not until investors begin to shrug off bad news and view pullbacks as “buying opportunities” have bull markets usually run their course.

And from a valuation standpoint, the S&P 500 trades for about 18 times trailing earnings per share.  While loftier than the historical average, the ninth innings of bull market runs accompany even higher multiples.

While we believe this bull market still has legs, all good things must eventually come to an end.  Therefore, to be prudent, we are continuing to rebalance client portfolios where appropriate.  This involves trimming outsized positions, adding to underperformers and realigning the mix between equities and fixed income.