It has been a very interesting year.
The fact that the S&P 500 closed up 2.89% through June 30th and up 1.23%
over the past full year masks the incredible market movements we have witnessed
over this time period. We saw a 12.5% drop a year ago ending with the August
24, 2015 flash crash. We then rallied to
within 1% of the 2134 SPX peak then
bottomed about 14.5% lower at 1810, this winter. Those who got out, missed a
subsequent 17% rally back to the SPX 2120 level.
While the 15-year return for the SPX
has been +3.67 % annualized, the 10-year return was +5.17 % and the 5-year
return was 9.44%.
Long term bonds rose 12.43% YTD, while
Corporate Bonds added +7.02% and High Yield bonds +5.4% beat the stock market
averages.
Why are bonds outperforming stocks
in this environment of slow growth and near deflationary trends?
The answer is that this economic
cycle is without recent precedent. GDP growth for the U.S. has been about half
the rate of prior recoveries post WW II.
Central Bankers have tried to control
of interest rates via interest rate repression and quantitative policies which
use money, they have created from thin air to purchase government bonds as well
as other liquid assets.
In an all-out effort to avoid
recession and even worse global coordinated rate cuts and money creation have led
to historically low rates around the globe.
Bill Gross points out in his July
missive that "credit growth has averaged 9% a year since the beginning of
the century and barely reaches 4% annualized in most quarters now."
"Credit, he states, is the oil
that lubes the system, the straw that stirs the drink
and when the private system fails to
generate sufficient credit growth, then real economic growth stalls
and even goes in reverse."
Britain's exit from the European
Union was the choice of the majority of UK voters and it has set off another
wave of fear that the world GDP will slow even further.
Ten year U.S. Treasury notes now
yield 1.36%, new all-time low levels. Canadian 10 year's yield 0.98%.
In Europe the yield rundown in the 10-year
maturity is as follows:
Switzerland -0.68%, Germany -0.19%,
Netherlands +0.02%, France +0.13%, UK+0.77%, Spain +1.18% and Italy +1.%.
In Japan we see a -0.26% yield on 10
year notes. In spite of their massive money printing apparatus the Yen has
appreciated from 122.57 to 101.31 to the U.S. dollar.
In spite of a down grade of the UK
government bond rating by Moody's from AAA to AA1, bond yields in the UK have
plunged below 1%.
These market responses indicate that
Central Banks have reached the limits of their powers. Even so, market
participants are still choosing to take refuge in Government bonds. Nearly $10
Trillion of sovereign debt, mostly in Germany and Japan has a negative yield.
A return of capital has clearly
begun to trump a return on capital when investors are willing to loan money
over long periods of time for guaranteed negative returns.
What are the implications for our
financial markets?
So far monetary actions by central
banks has lowered interest rates in order to stave off recession and repair
balance sheets.
Central bankers have managed to help
keep developed economies GDP above the zero line. They have thereby stimulated
housing demand, auto sales, share buybacks and new bond issuance by corporations.
We have seen the coming and going of
Capital spending in the energy patch as well as in the technology sector both
of which led to fortunes being made and unemployment rates dropping.
However, with anemic growth rates in
the U.S., Europe and Japan compared with past recoveries much of the population
feels squeezed or even left out. Emerging economies like China have slowed and
Brazil is in a deep recession.
This has led to the rise of
discontent on both the left and the right of the political spectrum.
As the Brexit demonstrates many
voters are tired of the status quo and have begun to demand real change and are
willing to take the risks associated with new beginnings.
Gold has rallied some 30% off its
late November 2015 lows while remaining about 30% below 2011 highs.
Stock prices have stalled but
certain sectors have benefited in this changing landscape while others have
been badly hurt.
We believe a period of uncertainty always
presents opportunities.
Fact set places the forward P/E on
the S&P 500 index at 16.4 X. This P/E ratio remains above the 5-year
average of 14.6 x estimated earnings.
With the Brexit decision we see new opportunities
abroad where P/E s are lower and dividend yields are higher. We expect the
continued debasement of paper money to prop up stocks, and precious metal
prices.
Doug Coppola
John Coppola
July 6,
2016
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