As earnings continue to hit the newswires this week, Wall Street is looking for some shelter from rough weather by attempting to differentiate between what is noise, and what isn’t. So far, according to Yahoo Finance, three quarters of the companies that reported have topped earnings expectations, while less than half have reported revenues above consensus estimates (below the historical average of 58%). With slower growth than projected, this week’s US GDP report should provide significant clarity on when the Fed may raise interest rates. At this stage, caution, in our opinion, is the price required to pay for perfection; while the upside for the markets this year remains plenty, we think the ability of investors to weather through thick and thin has seriously worn out. The S&P 500 is up more than 210% since the 2009 bottom, and continues to hit record highs, along with the Japanese Nikkei. The Nasdaq has now regained its 2000 peak, and Europe has returned over 20% this year. At the same time, growth has been far slower than expected, monetary policies worldwide have played a much bigger role in increasing risky asset prices than during previous bull runs, and income divergence has dramatically increased – picture this – there are now 14,600 families with at least $100 million in assets globally, up 42% since 2008, according to Bloomberg Markets. Meanwhile, US wages haven’t really moved since the recession. So, people that are rich enough to participate in the markets have prospered, while the rest, not nearly as much. Meanwhile, valuations for large private companies, a subject we highlighted in our March 8th column, have gone up 68% in just six months, according to the WSJ’s Billion Dollar Club data. Investors are scraping for yield wherever it’s available. The combination of all these factors is uncharted territory for the bulls – and it only takes a few to start a stampede backwards. The Shiller CAPE ratio is indicating that the S&P 500 is at 27, well above the median of 16. However, the rest of the developed world is at 17, below the median of 22.5, highlighted by Barron’s. Consequently, as all of Wall Street boards overbooked capital flights to Europe and Japan, it’s worth keeping an eye on discounts elsewhere, especially considering the major risk that lies in the hands of Greek politicians – which frankly we have zero control over. Staying invested is the right approach, but taking short-term positions at the moment is – we keep reiterating our broken record – more akin to betting on people rather than on company fundamentals. With this overview in mind, here are two subjects worth highlighting this week:
ETFs: The popularity of ETFs – a phenomenal product, worries us a bit – even though we use it plenty ourselves. The reason? All the stocks, as single baskets, go up and down at the click of a key. Consequently, given a continued rise in the assets in this product, mispricing might occur more frequently among companies that don’t deserve to be yanked up or down with their entire sector or geography. Also, due to the user-friendly liquidity of ETFs, market downturns (or even upturns) can be dramatically exaggerated due to automated buying or selling of entire sectors en masse. ETFs account for 25% of total market turnover, according to Goldman Sachs, 10% higher than 10 years ago. As this is projected to increase with time, it’s worth keeping an eye for some diamonds in the coal mines as investors move the passive route and start differentiating less between the quality of individual companies.
Macro: This week, conversations on the ground with German export-oriented business owners re-emphasized our continued confidence in the German stock market. The cheap Euro continues to help exports, multinationals are steadily investing in capex, and the country continues to benefit for these, as well as other reasons described in our January 14th column. We reiterate buying the HEWG ETF, especially if the Greek story goes downhill this week – as our focus is on the structural strength, and not the impact of policies. We also believe the Greek outcome will be an important factor in Germany’s decision (amid continuing US pressure) to start lowering its current account surplus to aid global economic growth. Meanwhile, we highlighted Mexico in our January 25th column, and reiterate a strong buying opportunity here. The country’s current account deficit is less than 2%, its got among the most diversified GDP sector contributions in emerging markets, and while the forward P/E indicates a slightly expensive 18.6 compared to the 10-year average of 14.8 (at the end of Q1, according to JP Morgan), we think there’s plenty of room to run as the Peso continues to hold its ground. The Global Competitiveness Report by the World Economic Forum indicates that ‘Mexico (61st) has adopted important structural reforms in the past year’. With elections around the corner, this statement is key, and the country remains among our favorites, along with India. Meanwhile, China remains in the headlines, but the demographic trends there worry us a bit. We’ll be elaborating on this next week.
What it means for you: Staying invested works. The worst 20-calendar year stretch in two decades through 1948 still resulted in a 3.1% annual gain, according to Morningstar, highlighted by the WSJ. As we keep reiterating, global markets at the moment are heavily impacted by monetary and fiscal policies, and corresponding investor actions have led to riskier assets getting priced to serious perfection. While this doesn’t cap the remaining year’s upside, we believe it’s wiser to invest in structural stories and themes, rather than betting, essentially, on what direction policy makers will take. Stay in cruise control on Wall Street as earnings play out, the US GDP report reveals the first quarter’s progress, and watch for whether Greece is able to pay the bills this week.
