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Should Investors Take Notice When Reward Prospects Diminish?
The world’s central banks devise conventional and unconventional ways to depress interest rates. The impact? Consumers purchase goods and services on credit with favorable financing terms. Corporations issue low-yielding debt in order to buy back shares of their own stock. And governments issue low-yielding treasuries to continue spending far more than they generate in tax revenue. For some investors, then, the only thing that matters in the determination of whether to acquire assets like stock and real estate is ultra-low interest rate policy. On the other hand, what if the macro-economic environment is deteriorating? Should investors ignore wavering home sale trends, declining consumer sentiment, faltering retail developments, floundering total business sales, weakening economic growth on the domestic front as well as economic stagnation on the world stage? When things are getting worse, investors ought to take notice. Why? Because the central banks may not be capable of arresting the development of bear market declines indefinitely. In spite of ever-decreasing mortgage rates over the last year, do pending home sales appear to be accelerating or decelerating? They seem to be getting worse to me. Perhaps real estate asset prices have climbed to a level that even a 3.5% 30-year mortgage cannot fix. Surely, consumers are giddy about low gas prices and bountiful job opportunities, right? And yet, consumer sentiment has been trending lower and lower over the past 12 months. Perhaps consumers are spending more of their money from energy savings and fat paychecks at a variety of retailers. Nope, that’s not it. Maybe retailers are the only stragglers? Unfortunately, that’s not the case either. Corporations have been languishing to sell their goods and services since the business cycle peaked in July of 2014. Theoretically speaking, investors would want to be careful about owning companies that are selling less. One should feel more comfortable about paying up when sales per stock share are climbing. However, when revenue per stock share is wilting, one should recognize that he/she is paying an exorbitant price relative to those declining sales. The S&P 500 has not been this overvalued (1.86) since the dot-com tech wreck collapsed in the early 2000s. Well, it might be that corporate profits are all that matter. Earnings have been looking better, haven’t they? Hardly. The price investors have been willing to pay relative to GAAP S&P 500 earnings has been hitting extraordinary overvaluation levels (24x). What’s more, earnings per share have been falling each quarter since Q3 2014. Is it possible that some of these trends will reverse themselves if the underlying economics around the globe improves? After all, China may be stabilizing, Japan may be escaping its recession and the euro-zone may be gradually recovering. I am not sure there’s a whole lot of evidence for those suppositions. China’s economy just posted its slowest quarterly growth in seven years (6.7%). Japan and the euro-zone now rely on the lunacy of negative interest rate policy . The International Monetary Fund (NYSE: IMF ) just cut its global growth forecast. And world trade has not looked this anemic since the Great Recession. Bottom line? There will be a point where a lack of sales and a lack of profits will collide with the endless hope for central bank low rate manipulation. And the result is not likely to pretty. I am maintaining the lower-risk asset allocation that I have had in place for roughly a year. Specifically, we remain underweight equities for our moderate growth-and-income clients. Our current allocation of 45%-50% stock – only large-cap U.S. stock – is spread across ETFs holdings such as the iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ), the iShares MSCI USA Quality Factor ETF (NYSEARCA: QUAL ) and the Vanguard High Dividend Yield ETF (NYSEARCA: VYM ). Our current allocation of 25%-30% to income holdings – only investment grade – is spread across ETF holdings such as the iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ), the Vanguard Long-Term Corporate Bond Index ETF (NASDAQ: VCLT ) and the SPDR Nuveen Barclays Municipal Bond ETF (NYSEARCA: TFI ). The remaining 20%-30% in cash equivalents continues to provide value as a buffer against downside volatility, as well as serve as a storage place until it is time to acquire assets at more attractive prices. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. 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Fund Managers Are A Frightened Lot!
Today we will focus on Merrill Lynch’s monthly survey of global fund managers, who overlook around $600 billion in AUM. Majority of the time, but not always, surveys such as these should be taken from the contrary perspective and include some great insights as to how the consensus is positioned. As always, there are some pretty good charts and interesting observations, so let’s get started. Click to enlarge Equity allocations remain quite low, especially when one considers the recent multi-month powerful rally in global equities. Fund managers allocations towards the stock market fell to 9% overweight this month, from 13% last month and 54% in April 2015 (just before equities rolled over). The chart above shows that data with MSCI Hong Kong, which has been one of the most oversold markets since the Chinese rout began. However, on our Twitter account readers can also see the same data with the MSCI Australia index. We would assume equities have further to run based on this data alone, however we would advise caution on using only one indicator to make your financial decisions. Click to enlarge Bond allocations remained similar to previous two months, as readings came in at 38% underweight. Worth noting however, fund managers were 64% underweight in December, just before the equity market sold off and bond market rallied. In the chart above, we have shown the difference in allocation of equities vs bonds, together with the ratio of stocks vs bonds. Globally, managers have been quite risk averse. While positioning towards the debt markets is not that extreme (allocations have risen to 20% underweight or even higher historically), there are other sentiment gauges arguing that Treasury yields could rise somewhat from here. Click to enlarge Firstly, small speculators positioning in the futures market shows dumb money is chasing Treasuries with an expectation of lower yields. Secondly, Mark Hulbert’s Bond Newsletter Sentiment Index ( click here to see the chart ) shows record bullish recommendations by various advisors and newsletter writers. Thirdly, number of shares outstanding on various Treasury ETFs has spiked in recent weeks ( click here for the chart, thanks to Tom McClellan ). Finally, according to ICI, fund inflows towards government bonds have been very elevated for weeks. Putting it all together, one can see that there is room for unwinding of positions in the Treasury bond market. We have been long for a few months now and have recently changed our duration towards very short term Treasuries and Corporate grade bonds, as we expect a correction. Having said that, Treasuries still remain attractive for three reasons: 1) relative to rest of the developed world, Treasuries look attractive and could be considered high yielding sovereigns with only Australia & New Zealand paying you more; 2) we still continue to favour assets priced in US dollars as we see the greenback resume its bull market once the current correction runs its course; and… Click to enlarge … 3) we think that longer duration Treasury yields could eventually break down from the technical consolidation patterns. Click to enlarge Finally, cash balance increased in the month of April to 5.4%, from 5.1% a month earlier. As already discussed above, despite a very strong multi-month stock market rally, fund managers continue to hold extremely high levels of cash. Risk averse behavior resembles bear markets of 2000-02 and 2007-09, however, year to date performance of all major asset classes is pretty much positive (chart below). Click to enlarge Our take on high cash allocations by fund managers requires an investor to step away from day to day activities of the financial market, and focus on the longer-term picture. We believe there is an overvaluation in all major asset classes, where global central bankers have goosed up and inflated value of just about everything. We are very nervous and seem not to be the only ones with this view (Bloomberg: Peter Thiel Says Just About Everything Is Overvalued ). Bonds and cash are more expensive than they have ever been, with yields on Treasuries lower than at any other time in the last 220 years. Europe and Japan have gone into “la-la land” of negative interest rates, something that hasn’t happened in over 5,000 years of recorded history . Cash yields essentially zero or even negative in some countries. US stocks are the most expensive ever, apart from a few months during dot com bubble, with some metrics showing future expected returns to be flat over the coming decade. Basically, we have a situation where stocks, bonds and cash are expensive all at once. Depending on how events unfold, returns on all major asset classes could be very low or even negative (in tandem). No wonder global fund managers are frightened! Original post