Today is not the roaring 1920sSubmitted by Antaeus Wealth Advisors on August 12th, 2015
- Percentage of U.S. homeowner’s underwater on their mortgages as of 03/31/15:15%. (Zillow)
- U.S. corporate operating margins as of 03/31/07: 19.9%. As of 03/31/15: 17.3%. (Barron’s)
- Average American household credit-card debt as of 03/31/15: $7,177. (Card Hub)
- Share of Americans who have spent their gasoline savings on discretionary items such as eating out and vacations 14%. Share who have saved or invested their savings: 23%. (Bankrate.com, June 2015)
- Percent of bonds yielding more than 4% in 2006: 95%. In 2014: 15%. (BlackRock)
- Average annual U.S. Gross Domestic Product (GDP) growth in real output per worker from 1955 to 1964: 2.3%. From 1995 to 2004: 2.1%. From 2005 to 2014:1.1%. (Bureau of Economic Analysis, J.P. Morgan Asset Management)
- Net U.S. job creation in millions since February 2010 in Information, Finance and Business Services: +3.7. In Government: (0.6). (Bureau of Labor Statistics, J.P. Morgan Asset Management)
- U.S. trade deficit as percentage of GDP in the 4th quarter of 2005: (6.3%). In the 1stquarter of 2015: (2.6%). (Bureau of Economic Analysis, J.P. Morgan Asset Management)
- Increase in the global consumption of oil since 2013: 3.8%. In the U.S. since 2013:2.7%. (U.S. Energy Information Administration)
- Total return of U.S. large stocks during the 146-month bull market of the 1950s and early 1960s: +698%. During the 135-month bull market of the 1990s and early 2000s: +523%. Total loss during the 34-month bear market of the 1930s: (83%). During the 16-month bear market of the late 2000s: (51%). (Morningstar)
Year to Date (YTD)
The most obvious themes thus far in 2015 have been a strengthening of the U.S. dollar, a drop in commodities’ prices, and ongoing “unconventional” interventions by central banks around the world. While Antaeus believes U.S. stocks may climb higher by year end, we expect a bumpier ride going forward – including perhaps a correction along the way. Further, while stocks are relatively expensive compared to their long-term averages, arguably they are less expensive than bonds overall, and buckets of cash remain on the sidelines. Further, trading ranges have been tight and volatility has been low in 2015 despite various challenges – such as stalling growth in China and Greece’s crisis – indicating resilience in stocks.
As of August 10, 2015, the YTD total return (price appreciation + dividends) of various indices has been led by developed international stock markets: MSCI Europe Australasia and Far East Index +7.99% vs. S&P 500 Index +4.71%. Emerging markets have continued to struggle, with the MSCI Emerging Markets Index falling (5.62%); and gold and silver prices are near five year lows, down (6.70%) and (1.80%) respectively. Investment-grade bonds, as represented by the Barclays Capital Aggregate Index (price appreciation + interest), have returned just +1.49% in 2015; whereas private equity has shined.
The U.S. economy appears to be strong. Though obviously hurting many “frackers,” low oil prices are helping U.S. multinational companies, even with the headwind of a strong U.S. Dollar. Antaeus expects that the U.S. economy to grow a bit over 2% in 2015, and interest rates to rise before the end of the 3rd quarter: Janet Yellen seems ready to prove that like a recovering patient, the U.S. economy can get out of bed and stand up on its own. Our assessment is that the U.S. perhaps is in the 7th inning of this economic expansion.
Though the world economy remains sluggish and mixed, we do not expect it to break down, perhaps growing in the 3% to 3.5% range in 2015. For example, as a country importing almost all of its energy, Japan has enjoyed a huge benefit from low oil prices and extraordinary low costs of capital, whereas falling energy prices may have pulled Canada into recession. Similarly, while India has strong fundamentals, China seems to be stalling.
We anticipate increasing turbulence coming from Puerto Rico: debt has soared, economic growth has stalled, younger workers are fleeing and the work-force participation rate is a dismal 40%. Sooner or later, this tale will need an ending. In Europe, while Greece may not be as serious as some think for the Euro, the political ramifications are hard to predict, and the situation is eerily similar to the subprime mortgage bubble of the 2000s: those who dismissed the risk ultimately were wrong with immense consequences.
While we don’t appear to be in a bubble – today is not the roaring 1920s when shoe-shiners offered stock tips or the dot.com delirium of the 1990s when taxi drivers day-traded – valuations are rather high. For instance, as of June 30th, Goldman Sachs pegged the Cyclically Adjusted Price-to-Earnings (CAPE) ratio of U.S. stocks at 23x, suggesting, in the bank’s opinion, 10-year annualized forward equity returns of just 5.1%.
Geographically two pockets of value remain: Europe and Japan. Japanese stocks look inexpensive relative to those in the U.S., and the management of many Japanese companies is focused on adding value for shareholders by increasing returns on equity and capital. While many firms still function as risk-averse bureaucracies, some of Japan’s most prominent companies are changing their stripes and sitting on significant amounts of retained earnings. In Europe, accelerating domestic consumption has sparked economic growth, and a strong U.S. Dollar has provided an environment ripe for exports.
While we believe the likelihood of these events happening are rather low, the risks to a sustained sell-off in global stocks include an escalation of the Russia/Ukraine conflict, a hard landing in China’s opaque economy, a significant rise in interest rates, and a liquidity crisis in bond markets. As mentioned earlier, central banks are so intertwined in the global economy that they must now harmonize the two targets of balancing economies and avoiding credit bubbles (the latter which can lead to financial crises): a difficult task to carry out successfully.
U.S. corporate profit margins may be peaking and wages are rising (the latter helps U.S. workers and their families of course), which along with a strong U.S. Dollar, suggest slowing corporate earnings growth. Emerging Markets (EM) are coming off three bubbles that will take time to work through: credit, commodities and construction; and those countries and companies sensitive to the U.S. Dollar and Federal Reserve’s policies are especially vulnerable. Finally, though stocks in Japan and Europe are attractive today, the long-term picture is rather bleak for these regions as they face high levels of debt and shrinking populations.
While not guaranteed and subject to change, below are some of Antaeus’ expectations:
- U.S. inflation will accelerate over the next few years, yet stay relatively low for the next two decades due to the sheer number of aging baby boomers.
- 10 Year Treasury Bonds may yield 4% by the end of 2016 (yield on 08/10/15 = 2.24%), indicating pain ahead for long-term Treasuries.
- Convertible securities appear to be compelling for the next few years.
- Overall portfolio returns will be compressed compared to their long-term averages due to low interest rates and today’s high valuations.
- Aging populations will bring investment opportunities in biotechnology and healthcare. Infrastructure, smart and connected devices also will provide investment opportunities.
- 750 million people are projected to flood the emerging-markets middle class over the next 15 years, providing many investment opportunities in EM.
- Continued expansion in 2016 seems likely for real estate, especially in office and industrial properties, though prices may start to stagnate in a few years as higher interest rates take hold.
Given the above, Antaeus is looking at high yield bonds more favorably than a year ago, though we prefer vehicles with liquidity restrictions to prevent a “forced seller” situation if the masses start trying to unload bonds. We recently updated our strategic models: increasing convertible bonds and small-cap international stocks, adding Treasury Inflation Protected Securities, and reducing short-term corporate and municipal bonds. That said, as the current bull market matures, we do anticipate reducing the overall risk of our models within the next 18 months.
As we view the U.S. economy as healthy, we intend to capitalize on opportunities created by drawdowns in stocks. With low interest rates and relatively high valuations, we prefer stocks with growing dividends in this environment. Antaeus also continues to utilize bond ladders for investment-grade bonds where appropriate, as ladders tend to perform well in rising rate scenarios: they capture price appreciation as bonds roll down the yield curve and their remaining lives shorten.
Investors often chase past performance to their detriment. Study after study shows that investors loathe losses about three times as much as they love gains. While diversification may have felt disappointing over the past few years – with U.S. stocks trouncing most asset classes – remember that diversification helps prevent fear and greed dictating one’s investment decisions, thus typically leading to better long-term results.
A burning question remains: did the Federal Reserve leave interest rates too low, too long, distorting the pricing of risk and accelerating the creation of global debt? Was saving businesses that would fail in normal times by repressing savers worth it? Time will tell.
Evan P. Welch, CFP®, AIF®
Chief Investment Officer
Antaeus Wealth Advisors, LLC
August 11, 2015
Disclosure:Indices mentioned are unmanaged and it is not possible to invest directly in an index. No single strategy can assure profit or guarantee against loss. Past performance does not indicate future returns. The opinions expressed in this commentary are solely those of Antaeus Wealth Advisors, LLC and are based on information believed to be reliable; however, these views may change as information changes or becomes out of date. c 2015.
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