Every month, Steve reviews several market valuation metrics in an effort to provide visibility into forward 7- and 10-year returns. In this week’s On My Radar, Steve looks at Median P/E and Warren Buffett’s favorite measure, Total Stock Market Cap to Gross Domestic Product. Additionally, Steve shares GMO’s 7-Year Asset Class Real Return Forecasts. It’s a must-read!READ MORE
In their May market review, Arthur Grizzle, CFA and Charles Culver of Martello Investments wrote an article called “Markets in a Post-Volatility World.”
We wanted to share the following selected bullet points from the piece:
- Market Volatility: Global equity markets, and especially the US stock market, have shown remarkable resilience despite elevated valuations and an onslaught of negative news.
- The last few months have seen increased dysfunction in Washington, rising geopolitical tension particularly saber-rattling from North Korea and increased terrorism in Europe, weak economic growth, and the prospect of the Fed unwinding nearly a decade of stimulative monetary policy.
- Nevertheless, market volatility sits near historic lows on both an implied and realized basis.
- Structurally, investors can analyze market volatility in two distinct ways: realized volatility (how volatile something has been historically) and implied volatility (expectations for future volatility based on the price of derivatives).
- In both cases, US stocks have shown dramatically low levels of volatility in recent years. Implied volatility is easiest tracked using the CBOE Market Volatility Index (VIX), which derives its price from the implied volatility of options on the S&P 500 Index.
- In May, VIX broke under 10 for the first time since 2007. Indeed, there have been only two other periods since 1990 that the VIX reached a 9-handle; one was in late 1993 through early 1994, and the other in late 2006 through early 2007.
- In each case, the index ultimately re-rated to higher levels, though in only the more recent example of 2006-2007 was this eventually accompanied by lower equity prices.
In Friday’s On My Radar, Steve Blumenthal wrote, “Last Monday, the VIX broke below 10 to close at 9.77, the lowest level in more than a decade. There are only three other days the index has closed at lower levels, all of them in December 1993. Investors are complacent to risk. They shouldn’t be.”
Investment consulting firm 720Global also recently wrote about market volatility in The Unseen, “Volatility: A Misleading Measure of Risk.”
As investors, we are negligent if we follow the Fed’s lead into this complacent stupor. By prodding economic growth with unproductive debt and reigniting asset bubbles, the central banks have simply done more of what created the spasms of 2008 in the first place. Despite the markets calm façade and historically low perception of risk, the vast chasm that lies between perceived risk and reality is troublesome.READ MORE
Notwithstanding historically high market valuations, market flows continue into U.S. equities, specifically (see the chart below) into Large Caps and Total Market.
In certain strategies, we remain “risk on” with an allocation to equities, however you have to find something that works for you. Something that you can have full conviction in… then stick to your process. For your core portfolio allocations, you could diversify to several global ETF trading strategies.
Broad diversification is key. On the other side of the next recession is the next great equity market opportunity. It is not today.
Read more in this week’s On My Radar.ON MY RADAR
In the May 5th issue of On My Radar, Steve Blumenthal provides his popular survey of current market valuation and 10-year forward returns forecast.
First, Steve offers a quick primer on valuation and price-to-earnings (P/E) in layman’s terms. Most investors (and even some financial advisors) don’t understand valuation methodologies and how median P/E works and what it tells us.
Steve presents a number of informative charts that advisors can use in their own valuation work and to discuss valuation and forward returns with their clients.
In sum, the broad market (i.e., S&P 500) remains very expensive and overvalued according to several metrics and 10-year forward returns are likely to be muted (0%-3% before inflation). Steve says, “We clearly find ourselves today in a high valuation and low potential forward return environment.” Click below to access the charts and Steve’s analysis!ON MY RADAR
Early each month, we look at market valuations to see where we are. It’s also important to consider what valuations may indicate with respect to probable (7- and 10-year) forward returns. We believe risk is most when we feel it least and the risk is least when we feel it most. Today, we feel it least.
In Friday’s On My Radar, we presented several valuation charts, including median price-to-earnings (P/E) and Warren Buffett’s favorite.
Bottom line: the market remains overvalued. Trend following strategies can help you participate and protect.
We have four interns this year. At the start of their internships, we required that they read “How the Economic Machine Works” by Ray Dalio. The paper discusses how central bankers have certain levers they can pull, such as raising and lowering interest rates and other tools to speed up or slow down the economy.
I told them that I’m thrilled our fixed income strategies are doing well yet the unprecedented central bank experiments have so distorted price discovery that I just don’t know if I should scream or shout. I’m concerned that the Fed has boxed itself into a Keynesian corner.
By Steve Blumenthal, CEO, CMG Capital Management Group Inc.
Bond yields rose again this week and are nearing an 8-month high.
Rising yields are good for some stocks and bad for others. Dividend payers, REITs and Utilities have been among the recent worst performers.
Alternately, banks and life insurance stocks have been rising since January and strong again last week. Bond yields began rising in early February. The 10-year Treasury yield has gone from 1.67% (YTD low on February 2) to 2.48% last Friday.