Amazed and Confused

US Equity markets have been on a ten-year UPward trajectory since the Great Recession. This is especially true compared to other markets around the world. Valuation differentials are hitting   historic spreads – Growth has vastly outperformed Value, and US Stocks rule the world. It is as difficult to reconcile these disparities, as it is to understate them.

This confounding state of affairs may be musically represented by this modified lyric (derived from the song “Dazed and Confused” released on the Led Zeppelin debut album in 1969):

I’ve been amazed and confused this year; yes, it’s true
Looking for markets that are positive for you
Pundits keep talkin,’ though none of them know
The direction of markets, above or below

These markets are both amazing and confusing at the same time. Look at it this way: Suppose I could buy a US Certificate of Deposit (CD) that pays me five bucks/year for $100, or an equivalent Euro CD also paying $5/year for only $70, or an Emerging Market CD also paying $5/year for only $55. What would you do? Ignoring principal risk, the US CD is very expensive vis-à-vis all others, and yet money is flooding into US investments rather than into the others.

While the rest of the world is the subject of a fire sale, the US is, at the very least, fully priced. I understand paying up for quality, but sometimes the extremes are difficult to ignore.

The S&P Index Dashboard for sector performance for the 3rd quarter reveals no surprises– almost all US Equity sectors are positive in the quarter and YTD. The opposite is true of non-US equities. But wait! Wait! There’s more. Nice comfortable, safe, bonds are mostly negative as well.

When the US Federal Reserve raised short-term rates at the end of September, US equity markets surprisingly took the news with a big yawn. I went back to check reality and confirmed that the Fed actually did raise rates with little market impact.

It seems the only trade right now is to Buy the US and Sell everything else. It is truly confounding and will certainly reverse itself at some unknown future point.

King Dollar Rules

Some of the disparity is attributable to the relentlessly upward-climbing US dollar. As the US raises interest rates and sells bonds, the dollar must strengthen. It simply pays more to own dollar-denominated securities than 10-year German bonds with persistently negative interest rates. Add this to the increased profitability of US-based business due to tax reform, a strong economy, and fully employed work force; and capital moves stateside. The US economy and the almighty dollar are hitting on all cylinders. Hence the difference in market returns.

It is important to note that although these conditions remain persistent, they could change at any time. It is impossible to know when the wind will shift, so we will consistently invest for the long-term, while adjusting for increased risk of a contraction.

Of note: Through 6 recessions in 50 years, the Dow Jones Industrial Average is up 3200%.

Time flies when you’re having fun.

Tax Rates Driving GDP

Perhaps the biggest beneficiaries of lower US corporate tax rates are small and mid-cap US businesses which have limited ability to shelter income offshore. These companies are hiring and expanding, which are significant drivers of domestic GDP, and can be expected to drive the Bull market for another year or two – we will see. One thing is certain – my daily commute is far more challenging than ever because of all new commuters.

It is difficult to see what event may precipitate the next pullback. The economy is strong, unemployment low, and taxes favorable while ignoring a volatile political environment. Even though markets are extended they may continue to rise, as long as profits and incomes stay on an upward path. Fourth quarter corporate earnings announcements are projected to be strong again.

BUT please ignore anyone saying “Dow 30,000” — that would be tempting fate.

Investment Comment

At this time there appears to be some increasing near-term resistance to further equity market gains. The so-called FANG stocks have more recently faltered. Rising long-term interest rates are beginning to provide meaningful competition to equities even as they drive bond prices lower.

We are keeping a watchful eye on Europe, Asia, and Emerging markets – they will rebound, and probably with strength. We just don’t know when and will watch for signs of strength before making any changes.

Good news – though most bond sectors have sustained negative YTD returns, investments in fixed income – preferred shares, floating rate and short duration bonds — have delivered positive results. As the US Federal Reserve continues to raise rates, short-term investment yields will improve.

Final Thoughts

It may be an amazed and confused market condition for the moment – that is the reason to remain disciplined and focused on the long-term plan.

Nothing contained in this publication is intended to constitute legal, tax, securities or investment advice, nor an opinion concerning the appropriateness of any investment, nor a solicitation of any type and does not guarantee future results. The information contained in this publication should not be acted upon without specific legal, tax and investment advice from a licensed professional. Past results are not indicative of future performance.