In my view, the bet today comes down to this: you believe the Fed can hold the market up (aka “the Fed Put”), you believe politicians can accomplish structural reform and you believe that the same holds true in Europe, China and Japan. Essentially, “whatever it takes” wins.
Alternatively, you believe that extremely high equity market valuations matter, excessive debt is problematic and that it is ultimately impossible for central bankers, try as they might, to repeal economic business cycles.
Over the last four plus years, any whiff of higher rates has put the market into a tail spin. All periods have been followed by more dovish Fed comments. For now it remains “all ‘bout that Fed.” My best guess is that it will be wage and core inflation that forces Fed’s hand. To that there are some stirrings but nothing major on the inflation front to fear just yet. But before that takes flight, keep in mind that the Fed believes interest rates should be 1½% higher today. The systematic imbalances are plenty. The tipping point may likely be higher rates.
At the beginning of every month, I like to look at the most recent month-end valuations. It gives me some sense of just how much risk is embedded in the markets and also a good feel for what the probable 10-year annualized forward returns are likely to be. I mentioned in last week’s piece that the valuation numbers would likely come in higher and boy, did they! Median price-to-earnings ratio (my favorite measure) came in at 22.6. We sit at a higher level than the market peak in 2007.
For now, we collectively bow our heads to the Fed – and the ECB, JCB and CCB. But, as is taught in the world’s top business schools, valuations do matter. They are a powerful and reliable determinant of long-term investment returns.
By Steve Blumenthal | See the full story in On My Radar: A Powerful and Reliable Determinant of Long-Term Investment Returns.
The current opinions and forecasts expressed herein are solely those of Steve Blumenthal and are subject to change. They do not represent the opinions of CMG. CMGs trading strategies are quantitative and may hold a position that at any given time does not reflect Steve’s forecasts. Steve’s opinions and forecasts may not actually come to pass. Information on this site should not be used as a recommendation to buy or sell any investment product or strategy.