One of the of the most symbolic – and debated – characteristics of the post-recession financial world has been the influence of unconventional monetary policy on asset classes and corresponding returns. US and global growth has been below historical averages, economic leadership from the BRICS is no longer the fallback, the global working age population is increasing at a slower rate than the pre-recession era, and new technological breakthroughs and low demand have driven commodity price collapses, impacting budgets and sending the economies of nations worldwide scrambling for cover.
Amid such a unique economic environment, it is worth noting that certain asset classes, including US equities, have more than tripled from their recession bottoms. Last week was another interesting example of their interaction with monetary policy; as the ECB announced further stimulus potential and China lowered its benchmark interest rate, the S&P 500 finished up by 2.0% to reclaim positive ground for the year; the NASDAQ was up 2.97% alongside. As global easing measures further complicate the US Fed’s interest rate hike decision, the markets seem confident that policy divergence won’t occur for some time; Fed Fund futures are decisively pushing the first hike all the way back to March, with a 60% probability. Consequently, emerging markets are rallying, the dollar is weakening, and high-yield bond yields have also flattened out over the past two weeks. Do such indicators suggest that the coast is clear for equity investors in the short term?
We’re seeing caution. Playing equities by purely betting on the Fed rate hike may blind investors from the fundamentals – which continue to reflect warning signs. Our concern remains around the fact that the 10-year treasury yield – which had reached a high of 2.5% earlier this year – ended the week at 2.08% – essentially hovering around the year’s lows. Meanwhile, over half of the gains of the S&P 500 on Friday were driven by a handful of tech behemoths reporting incredible earnings – Amazon, Google, and Microsoft among the names – with Facebook entering the $300 billion market cap club alongside, per WSJ data. The success of such firms – and their size – can easily cause investors to glaze over the fact that revenue growth for Q3 so far has been missing expectations more so than expected, and earnings haven’t exactly been pleasant either. Per FactSet data, only 43% of companies that have reported Q3 earnings are showing sales above estimates, while the blended earnings decline is -3.8% – a back-to-back quarter decline. Corporate bond issuance, meanwhile, continues to show some cause for concern – companies continue to attempt to lock in debt at cheap yields while low rates persist; average corporate debt maturity was at 21.3 years in September, per SIFMA data, reported by CNBC – not only the highest length since record-keeping began in 1996, but also showing a 1-month jump of 39%, and a 45% gain from 2014. Again, the surge in corporate activity points to an attempt to capitalize on the rate hike window. Alongside, M&A activity – and the corresponding sizes of transactions – continue to overwhelm; the SABMiller-ABInBev merger valued at $104 billion, Dell’s bid for EMC, and other such transactions are significantly relying on debt for funding. Will investor sentiment remain bullish when the rate hike eventually occurs, and the cost of capital suddenly becomes higher?
What it means for you: Alongside capital appreciation, shareholder returns through dividends and buybacks, and corporate actions including capital structure changes, M&A activity, and real estate transactions continue to help corporations and investors maneuver through an incredibly complicated financial environment. It will be critical to distinguish – soon – between companies that have merely utilized the inexpensive liquidity to fund short-term activities versus those that have actually invested in decisions for the long term. Investors have been parched for yield for years, and equities have correspondingly been the go-to place. The risk remains that investors may have become short-sighted. A change in perception, expectations, and an ability to adjust will be necessary as and when a tighter monetary policy is implemented, and the next stage in the post-2008 recession era for the global economy begins. Thankfully, the market thinks this may not occur until March. As a result, staying focused on the corporate fundamentals to identify the real winners will be the key to returns, as investors swim through the choppy seas while Q3 earnings continue rolling out on Wall Street this week.
