Welcome to the BPO Capital LLC. market outlook newsletter. BPO Capital LLC. represents attractive investment options managed by institutional quality boutique managers that provide expertise in ‘risk reduction’ or an informational advantage that provides ‘alpha’ in addition to generating income that is independent of interest rate direction.
AT BPO, Our Mission is to help prepare advisors to have better conversations with clients in 2019 and beyond.
June was another month filled with lots of news and movement in the markets. The bell weather S&P 500 finished the month about where is started (up less than 1% for June and for the year), as it moved up strongly in the first half of June, and the came back down in the second half. Volatility (VIX) increased as the month went on, and interest rates are creeping higher. As the country heads towards elections this Fall, we are seeing a discord of “change” taking place in the primaries. The immigration topic has captured the public’s attention, President Trump had a historic summit with Kim Jung Un, there has been a lot of rhetoric on tariffs, and Justify won the Triple Crown. We believe that all of this leads towards a cycle of more uncertainty and unpredictability, vs the most recent cycle of fairly predictable outcomes (2012-2017),
As advisors and investors worked their way out of the Financial Meltdown, stability returned in a big way in mid-2012. It had taken billions in TARP assistance to create this stability. The equity markets had already had a huge move off the bottoms of 2009, but real confidence hadn’t returned. As interest rates remained at all-time lows, and equity marketing steadily drifting higher, there was little to give investors concern over the past six years. We are seeing signs this year, that concern has re-entered the mindset of investors and advisors. This summer is an excellent time to examine risk levels, re-balancing, asset allocations, and income sources to make sure that accounts are positioned with potential changes in mind.
The worst sell-off since April has many investors running for safety while the yield curve has flattened and may be threatening to go inverted. The recent rhetoric on trade may be the culprit. Lest not forget that domestic equities have beat bonds significantly through the second quarter, and it might be a time to pair back some of those gains. But reallocating into bonds – or cash – may not provide the risk management needed to protect client portfolios. Optimism over tax cuts may not be enough to offset this trade-
war posturing and the Fed has hinted that changes in trade policy ‘may affect the outlook for the economy.’ This has created uncertainty in the equity markets and the Treasury curve continues to flatten. The gap between 2- and 10-year yields reached its lowest level since 2007, prompting many Wall Street firms to question their forecasts, suggesting the curve may flatten even further. It appears the 10-year is having difficulty pushing above a 3% level. For the first time in almost 50 years, stock and bond prices are converging……..clients are in a yield crisis!
One of the best gauges of stock market valuation is the price/earnings based on average historical earnings. This helps eliminate the year over year “noise” in earnings figures reducing the impact of changes in tax laws, write-downs, and other momentary events. As the chart below reflects, the 10-Year average earnings measure- currently about 32X’s, has only been exceeded ONCE before: in 2000 representing the internet bubble peak! If we view it in 5-Year terms, it has only been exceeded twice, 2000 and 1937. Although there is no “sure fire” measurement that reflects market peaks (or bottoms), we stand by our previous newsletter in saying this market warrants caution.
A potentially better gauge and more indicative than the P/E is how much we pay for all U.S. stocks [the combined market cap of all U.S. Stocks] relative to the economic productive capacity of the United States [U.S. GDP]. The current ratio is a hair short of 1.5X’s – nearly matching the internet bubble peak. At no other time in 70 years of history has the ratio come close to this level!
While we are not in the prediction business, we see some trends that are worth noting because they imply that changes or reversions will take place at some point in time. As we see it, at some point the gap between the Nasdaq and the S&P 500 will have to narrow. Similarly, we see wide gaps between Discretionary and Non-Discretionary equities driven by anomalies in the market patterns.
DISCLOSURES: Past performance is not indicative of future results, which may vary. The value of investments and the income derived from investments can go down as well as up. It shall not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities mentioned here. BPO Capital LLC., is not recommending this product for actual clients, but rather using this material for financial advisor education purposes.