Current Bull Market Snapshot: The bull market is over five years old and has gone over 1000 days without a 10% correction. The current low levels of volatility are accompanied by low levels of bearishness.
A Focus on the Positive: The quarter was highlighted by a steady Fed and robust M&A activity.
Investors seemed to focus on solid corporate balance sheets, strong dividends and low and predictable interest rate policy as stocks advanced to new heights in June.
Just as July’s scorching temperatures have pushed January’s snow storms deep into our memory banks, stocks low volatility advance to new highs in June appears to have lulled investors into complacency. But as Game of Throne’s Ned Stark says, “Winter Is Coming”; it’s only a matter of time before a change in seasons. In the series, summers can last nine years or more but Ned also states, “Long summers lead to long winters.” Or to put it in another context, if extended good times ups optimism which in turn creates large imbalances, then the time to adjust can be long or violent. Fortunately, in the current U.S. equity cycle most measures of the market’s value such as price relative to earnings (S&P 500: 17.6) or our calculation of price to intrinsic value (S&P 500: 0.60) appear to us to indicate that large cap U.S. stocks are fairly priced. Hallmarks of the current bull market are length, low realized volatility and anticipated volatility. The bull market is over five years old and has gone over 1000 days without a 10% correction. The “original VIX” or S&P 100 VXO index reached a 38-year low at quarter end. While low expected or historic volatility is not necessarily a precursor of an upcoming decline, I am concerned that it is currently accompanied by low levels of bearishness. At quarter-end the American Association of Individual Investors index was just 21.1% and the put/call ratio fell to 0.43, the lowest level since January 2011.
Master of Coin
Some would argue that winter has come and gone as investors shrugged off 2014’s first quarter 2.9% GDP decline by sending large cap stocks up approximately 5% last quarter. Looking forward, investor’s ignored the harsh weather and seemed to focus on the underlying economic fundamentals of solid corporate balance sheets, strong dividends and low and predictable interest rate policy. The quarter was highlighted by a steady Fed and robust M&A activity. Thus far the tapering of quantitative easing has gone without incident. The $85 billion per month purchases of securities by the Fed has declined by $10 billion every Fed meeting and now stands at just $35 billion a month. The intent is to finish the QE experiment this October. Not only has the U.S. central bank provided liquidity to the markets – persistently reducing supply – but merger and acquisition activity appears to have caused repricing of many sectors closer to fair value. Global deal activity has reached $1.75 trillion in 2014, or a pace not seen since 2007. Pfizer’s failed bid for AstraZeneca and AbbVie’s pursuit of Shire appears to have changed valuation analysis to a focus on pre-tax income with recognition that moving U.S. companies to lower tax domiciles would mean greater returns to investors.
The Seven Kingdoms-Unsynchronized
The investment themes of the first quarter held fairly steady in the second quarter as companies with high dividends, low earnings yields and high profit margins led the performance tables year to date. Large caps continue to outpace small caps, value leads growth and the U.S. is outpacing Europe and Japan. Despite the hiccup in first quarter GDP, anticipated U.S. economic growth continues to be supported by new highs registered by the Leading Economic Indicators index (+6.7% May, year over year) and the positively sloping Treasury yield curve. Strong gains in both pending home sales (+6.1% May, year over year) and autos appear to have pushed the second quarter GDP advance to reverse the first quarter decline. Weak credit creation remains a lingering problem in parts of the rest of the world, especially in the euro zone. European banks are contracting credit to support higher capital ratios and consumer and business credit demand remains timid apparently reflecting weak levels of confidence. As such, French economic growth has been sluggish and German factory output has declined three months in a row. Chinese growth, however, appears to be stabilizing around 7 to 8% and Japan continues to on-balance benefit possibly from Prime Minister Shinzo Abe’s demand-side stimulation. In contrast with the early 2000s, emerging market growth is no longer synchronized to developed market growth. We see cross-currents across the globe in economic growth rates, monetary policy and stock prices.
A Lannister Always Pays His Debts…
But the Puerto Rican Power Authority and Argentinean Government do not. . .
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