Are All-time Highs Justified?
Doug Walters
The S&P 500 broke out to an all-time high this week leading many to ask if equities have gone too far too fast. In the end, it comes down to corporate earnings, which may benefit from recent positive economic data.
Market Review
Contributed by Doug Walters
Equities Go Marching
Stocks marched steadily higher this week taking the S&P 500 to all-time highs. The sell-off we experienced to start the year seems a distant memory now, as stocks have rallied almost 20% from the February low. The inevitable question whenever the words “all-time high” are uttered is, “are stocks too expensive at these levels?”
By traditional measures, like price-to-earnings ratio, U.S. equity valuations are above their long-term averages. While, true, we note:
- Stocks remain more attractive than bonds. The average dividend yield of the S&P 500 is nearly 2%, while the 10Y treasury yield is around 1.5%.
- The S&P 500 has grown at a fairly steady rate over the past 100 years. Today we are just slightly above that long-term trend growth (in 2000 and 2007 stocks were dramatically above trend).
- Current stock valuations are not extreme by historical measures. What is more important is the trajectory of future corporate earnings. Valuations can quickly fall if corporate profits rebound. In our economics section we note that the tone of recent U.S. economic data is positive, which bodes well for future corporate earnings. Of course, interest rates could also inflect to the upside which could be a potential headwind for risk assets.
Rooting Out Value
Despite the recent rally there is not a shortage of attractive investments to be found. Not all sectors and stocks have participated equally in the recent rise, and our disciplined, repeatable process is designed to root out these opportunities. Most notably in the recent rally is the lack of participation from the Tech sector.
| Indices & Price Returns | Week (%) | Year (%) |
|---|---|---|
| S&P 500 | 1.5 | 5.8 |
| S&P 400 (Mid Cap) | 1.5 | 10.4 |
| Russell 2000 (Small Cap) | 2.4 | 6.1 |
| MSCI EAFE (Developed International) | 3.6 | -3.9 |
| MSCI Emerging Markets | 4.7 | 9.3 |
| S&P GSCI (Commodities) | 0.9 | 15.9 |
| Gold | -2.8 | 25.0 |
| MSCI U.S. REIT Index | 0.3 | 13.1 |
| Barclays Int Govt Credit | -0.7 | 2.9 |
| Barclays US TIPS | -1.0 | 6.1 |
Economic Commentary
A Robust Economy…Finally?
The US economy is starting to show strength and leading the developed world in growth. Proof of the economy’s improving fundamentals came in this week with positive numbers in:
- Retail Sales is a leading indicator of the economy. This measure makes up one third of consumer spending with consumers themselves responsible for 70% of economic activity. June retail sales were up 0.6% over the previous month beating expectations of 0.1%.
- Industrial Production is an important leading indicator as the manufacturing sector is highly cyclical and sensitive towards demand especially when compared to the services sector, which is relatively stable and non-cyclical. Industrial production was up 0.6% last month beating expectations of 0.2%.
- Capacity Utilization is an important concept as it measures economic production over potential production. A high utilization rate would force businesses to spend more on increasing their capacity. The utilization rate was 75.4% in June, slightly beating expectations.
Consumer prices (inflation) is a lagging indicator that picks up after the economy heats up and drops after an economic downturn. Core inflation is still low but has ticked upwards over the past two years. Total inflation, which is equal to the core plus more volatile energy and food prices, is well below normal levels and increased by an annual rate of only 1.05% last month. This is a sign the economy is still reaping from the benefits of lower energy (i.e. oil, natural gas, coal) and lower food costs (i.e. corn, milk). Consumers are able to spend more on other products and stimulate the economy with their savings from lower priced commodities.
Week Ahead
Trump’s Moment
The first of the two major political party conventions during this Presidential Election season kicks off Monday as the Republican National Convention begins in Cleveland, OH.
- Presumptive Republican nominee Donald Trump is expected to officially accept the party nomination.
- Voters and the market will look to the businessman turned politician to clarify and release more of his stance on the US and World Economy.
May-be Some Stability?
In more political news, newly elected Conservative Party leader Theresa May has been appointed as the new British Prime Minister. The upcoming week will be her first full week in charge. She will take questions in front of Parliament.
- The world will be looking towards London to see if she can bring stability to the forecasts of the post-EU economy in the United Kingdom.
Technology Will Chip-In
The upcoming week features 21 Strategic holdings releasing quarterly earnings. Six of the companies come from the Information Technology Sector and 4 of those are semiconductor chip companies.
- EMC Corporation, QUALCOMM, Skyworks, Visa, Microsoft and Intel all report
- This is the first time reporting for each company since Brexit was announced. Investors will be looking for commentary on the potential business impact of the surprising referendum results.
Strategy Update
Contributed by Max Berkovich
Strategic Asset Allocation
¥en, Ben and Pokémon
While a Japanese mobile game was spreading like wild fire in the States, it was reelection of Shinzo Abe in a landslide that took developed international markets by storm. The reelected Prime Minister of Japan also brought a strong majority to his party in the lower house and to an allied party in the upper house as well. This result should make further fiscal stimulus easier to push through. Earlier numbers indicate 10 Trillion ¥en or 2% of the island nations’ GDP is in the works. A day after his victory the prime minister had former Fed Chairman Ben Bernanke visiting. The market assumes Helicopter Ben is there to advise on more stimulus. While the Nikkei has been moving higher all week the ¥en has been going in the opposite direction.
Strategic Growth
Think Inside the Yum!
Consumer sectors both staples and discretionary lagged the cyclical sectors this past week. Speaking of the consumer…
- Yum! Brands, Inc. (YUM) reported a mostly in-line quarter, but showed steady improvement across most of the business. As a matter of fact, enough improvement to have the company bump its full year guidance. The taco Bell division was probably its weakest division, but a “Cantina” concept popping up suddenly may change that. A flagship restaurant is planned on the Las Vegas strip later in the fall and an Atlanta location is next.
Strategic Equity Income
Fintastic!
Utilities and Telecom were laggards as interest rates bounced back from the post-Brexit lows. Financials on the other hand took charge as early earnings reports looked fantastic. Speaking of financials and earnings…
- The first big bank to report 2nd quarter results was JP Morgan & Co. (JPM). The report was a very good one. The bank topped estimates by $0.12 on the bottom line and $1Bil on the top line. The bank had revenue growth and was also successful at cutting costs at the same time. Commercial and Investment Banking net income was 33% higher from last year and Asset Management was up 16%.
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