Time in the market a critical factor
Global equities have continued to move higher as corporate earnings’ strength is offsetting some softening in economic data. Since the surprise victory of Donald Trump, the MSCI Index has risen over 12 per cent and year to date is up over 8 per cent.
By the end of 2017, earnings for the MSCI are expected to be $109.50. If the market were to stay flat from now until the end of the year, at this level of earnings the MSCI would trade at 17.2 times.
Put differently the earnings yield of the market would be 5.8 per cent which compares quite favourably to the US ten-year Treasury yield of 2.3 per cent.
While the overall market is not cheap, we believe that calls for an equity bubble are significantly premature as the headline valuations have been based on materially depressed earnings from one particular sector (energy) which are in the process of normalising.
European shares have performed well after the demise of the euro is less likely with recent trends in elections on the Continent and investors have become less concerned about Brexit risks. The outperformance of international markets is partially due to the recent decline in the dollar which has dropped over 3 per cent so far in 2017.
This fall in the dollar is a definite surprise as the overwhelming consensus at the start of the year was for a large dollar rally. Much of this surprise is due to the repricing of political risk in Europe which has helped propel the euro and the pound. The euro and the pound are now up 4.5 per cent and 5.4 per cent respectfully for the year.
Fixed-income securities have extended their rally based on myriad factors. Economic data like payrolls, housing starts and auto sales have fallen short of consensus forecasts and credit growth in the US has decelerated.
At the same time the reflation trade has been challenged due to set backs with President Trump’s proposed policies in Congress. In addition, geopolitical uncertainties like the missile strike in Syria, sabre-rattling with North Korea, the French elections and bickering over Brexit have put a “safety” bid under fixed-income securities.
The latest update to the Fed’s so-called dot plot indicates that the long-run target rate is 3 per cent. Although this number appears low from a historical perspective, it may actually be too high in the current economic environment.
According to a study by the renowned Fed economist Thomas Laubach and San Francisco Fed president John Williams, the neutral interest rate in the US is zero per cent (the neutral rate is the target rate minus inflation and this estimates the equilibrium where GDP is growing at its trend rate and inflation is stable).
Assuming that the Fed can fulfil its mandate of 2 per cent inflation in the long run, this would imply only a 2 per cent Fed funds target rate in order to achieve the estimated zero per cent neutral rate. A lower than expected target rate provides an anchor for the entire yield curve and has currently kept a ceiling on bond yields.
When the stock market does well we often get questions and concerns about its ability to continue to escalate. Surely we are set for a tumble? This of course is market timing. Our answer is always the same.
It is very hard if not impossible to time markets. Maybe the hardest part is that you need to make two extremely difficult decisions correctly: when to get out and when to get back in. This essentially means you need to overcome a series of psychological biases and be right twice.
If one is invested in stocks to steadily build and preserve wealth over a long period of time then the strategy should not include trying to jump in and out of the market based on short-term concerns or performance.
By attempting to be out in down periods many investors actually miss periods of exceptional returns and incur trading costs and market impact costs. It really is time in the market not timing the market that counts.
For example, I know people who exited the market in early 2008 (a good call) only to have never reinvested for all sorts of reasons (a very bad call).
Instead of trying to time the market, we would suggest that it is better to value individual positions (valuation timing if you prefer).
By knowing what companies or exposures that one owns and what they are worth, one essentially sticks to buying positions that are undervalued and selling those that are fully valued and avoiding those that are overvalued.
We will at some point have a correction. When this happens and exactly why will be only known afterward but I feel it will likely be somewhat due to disappointment in the pace of US policy.
It is very likely that the full extent of Trump’s aggressive tax policy and/or his infrastructure spending policy will not come to fruition as desired. It is more likely that some compromised version will be enacted and that this will take much longer than envisioned. Thus companies and strategies that tilt excessively towards a more extensive political policy reflation trade are likely to underwhelm going forward. In my opinion one would be better served focusing on secular and idiosyncratic positive stories which will likely provide better returns based on solid competitive underpinnings and less on hopes for aggressive policy resolutions.
Nathan Kowalski CPA, CA, CFA, CIM is the chief financial officer of Anchor Investment Management Ltd and the views expressed are his own
Disclaimer: This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by the author to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. Readers should consult their financial advisers prior to any investment decision. Index performance is shown for illustrative purposes only. You cannot invest directly in an index
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