Friday, 10th of August 2018
The heatwave afflicting the northern hemisphere is reinforcing our concerns expressed last week. Global warming is clearly upon us and the debate should shift away from why and whose fault it is towards the question of how to live in and with the new paradigm. We had brought-up the subject not because we have green blood in our veins but rather to try and focus on the economic effects – where should we look to allocate capital to benefit from the changes to come. We haven’t yet, still looking though…
The heat of the past couple of weeks has turned us towards philosophic thoughts. We have pondered the linguistic proposition of “Value” vs. “Price”. We feel many confuse these two terms – the first of whom are salespeople in all sectors: how many times did a salesperson tell you that the value of the article at hand was whatever exorbitant figure? To accentuate this statement, the seller invariably proves their point by showing you the price sticker. Proof indeed, but not of value but rather of price. The philosophical difference between these two words is huge: price is objective whilst value is subjective. In reality, when the value of an object appears higher than its price, we buy. When the opposite is valid, i.e. the price on a sticker appears to be much greater than the value inherent in the object, we don’t buy (if only we could sell short some perfumes, handbags and so many other things, we would!). Now let’s move away from the steps of town-hall and look at the stock markets. We will focus our attention on the classic, the S&P500 benchmark. Is it dear of cheap? Is it worth its’ price of some 2’853? If this figure (the Price) is below the perceived Value, we should buy, no?
Well, we saw this reference Price at about 2’700 at the close of business 2017. Then, the economic “price” inherent in this price was the implied P/E ratio of about 20X. Well, today, whilst at a higher price than at year end ’17, the economic price inherent is lower, as the P/E has come down the about 16.5X… The P/E is a ratio and when the “E” part of the equation rises at a 20% clip, a rise of 6% or so in the “P” part make for a cheapening… But no price exists in isolation, so let’s do some value comparisons. First let’s look at Gold, a reference of consistent if not constant value, at a price of $1’208 now, down some 7%. What happened to Oil prices? WTI at $66.50 per barrel is about 10% more expensive than it was at year-end. The reference comparison tool, with which we discount expectations of economic future values, is the yield on the US 10-year Treasury Note. Now it is at about 2.90%, essential constant. Yes, we can conclude that there is more “value” in today’s, near all-time high, price of equities.
Then there are side-effects from all sorts of people saying strange things. The effect of most is mainly on our nerves. From Elon Musk tweeting from a plane that he will take Tesla private at $420/share, causing a price spike upwards, much pain for short sellers, then as questions mounted as to how he could finance this, then the SEC looking around, we see TESLA stock trade below the “Tweet Level”. At least the Fed hasn’t taken to Tweeting yet. The Federal Reserve may need to raise interest rates to “somewhat restrictive” levels to combat the effects of recent fiscal stimulus on the U.S. economy, said Chicago Fed President Charles Evans in hawkish comments from one of the central bank’s most reliable doves. “If inflation continues to be on the order of 2, 2.2 (percent) — I’m not expecting it to get as high as 2.5 — that suggests only a modest amount of restrictiveness above our neutral rate might be called for in 2020,” Evans told reporters Thursday in Chicago. The Fed under Chairman Jerome Powell has raised rates twice this year and pencilled in two more moves in 2018, with investors widely expecting officials to act at their next meeting on Sept. 25-26. Evans, who has long been considered one of the most dovish officials at the U.S. central bank, said “it would not surprise me at all if we make a judgment to move to a somewhat restrictive setting,” citing roughly half a percentage point above his 2.75% estimate of neutral. The tone of his comments marks a shift in his thinking. As recently as December, Evans dissented against rate increases on the grounds that inflation expectations were too low and may prevent inflation from rising to the Fed’s 2% target.
Well, if even a certified Dove like Evans is turning Hawkish, why then, read through his interest rate chatter and see a strong economy looking ahead. This suggests that the earnings bonanza we are experiencing with Q2 results may well continue: we would not be surprized to see confirmation in Q3 results which could justify the market P/E multiple to return to its 20X of last year. Well, if this does happen, the S&P 500 should hit 3’200, some 12% up from here!
The side-swipes are many: we had a muted one yesterday with benign US PPI data and expect CPI today. Can give us a hiccup via the interest rates. Looking at the VIX we see it low, very low even at 11.98… the “Fear Index” is at its lows… The 2018 selloff in cryptocurrencies plumbed new depths on Wednesday after the U.S. Securities and Exchange Commission dented enthusiasts’ hopes for a VanEck exchange-traded fund backed by Bitcoin. A broad selloff in coins of all sizes reduced the market value of virtual currencies tracked by Coinmarketcap.com to about $230 billion, the lowest level since November. Digital assets have now lost about $600 billion since crypto-mania peaked in January, more than the market value of all but the four biggest companies in the S&P 500 Index.
From tweets to tech to trade wars, investors have had multiple reasons to bail out of stocks this year. Instead, the S&P 500 is just another nudge away from setting a fresh all-time high. Rather than get shaken by scary headlines, the market has maintained a laser-like focus on fundamentals. A growing economy, record-setting corporate earnings, and friendly atmosphere in the White House and the halls of Congress are feeding expectations that the second-longest bull market in history still has legs. Second-quarter earnings are on track to increase 24 percent from the same period a year ago, a growth rate about in line with the first quarter. The beat rate vs. Wall Street expectations is at 80%, which would mark the best level since FactSet began keeping track in 2008. The economy is still growing, with the second quarter’s 4.1% GDP growth rate looking sustainable at least in the near term. And if there’s one thing Wall Street knows, it’s that bear markets seldom happen during expansions. Central banks outside the U.S. also are combining with sovereign wealth funds to help prop up equity prices through holding exchange-traded funds that focus on the stock market, according to David Rosenberg, chief economist and strategist at Gluskin Sheff. By Rosenberg’s estimates, the Bank of Japan is holding $250 billion worth, the Swiss National Bank has $180 billion, and sovereign wealth funds also are devoting huge sums towards stock ownership. Oil-rich Norway, for one, has 60 percent of its $860 billion in sovereign wealth assets dedicated to equities. “It’s not a conspiracy theory. It’s just a reality,” he added. “The plunge protection police is global and with very deep pockets.”
As much as President Donald Trump’s tweets, the global trade war he has launched, and the general political rancour he has promoted have rattled the markets, the damage only lasts a while. Then the market moves back to fundamentals just as quickly. The next big headwind out of Washington is the midterm elections. The results could set up divided government officially if current punditry is correct. If these elections will lead to a frozen administration, which sounds nasty, history shows us that the markets like it: Government can’t and won’t do anything, and as we all hate surprises, that is good…
We think that we have time to enjoy capital appreciation into quite a while ahead. J.P. Morgan Chase chief Jamie Dimon says people should prepare for U.S. yields of 5 percent, warning investors that borrowing costs throughout the economy are likely to rise beyond even his prior forecasts. Though the bank chief previously theorized that the yield on the benchmark 10-year Treasury note could reach 4% in 2018, his comments Saturday at the Aspen Institute’s 25th Annual Summer Celebration Gala appeared to reflect his belief in a stronger economy. “I think rates should be 4% today,” Dimon said. “You better be prepared to deal with rates 5% or higher — it’s a higher probability than most people think.” Well, if indeed he is right, that would be because the economy roars ahead… the high rates he worries about will slow down the phase to follow.
The party is still “On” 😊
We do have a worried eye on the “No-Deal Brexit” clouds. No one can say what this would do and to whom. As we said, markets dislike uncertainty… And we see trouble for Turkey as the Lira falls to fresh record lows as their 10-year yields surge to 20%!?! Don’t be tempted to catch this falling knife…
We leave you with the thought that maybe if we start telling people that the brain is an App, they will start using it…
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