Mon, APR 20th, 2015
“It’s déjà vu all over again.” — Yogi Berra
Entering 2014 many professional prognosticators opined that while the American economy was accelerating interest rates were too low to be sustained and U.S. stocks were expensive. Further they worried that even though inflation was anemic the Fed was inching towards raising rates. Meanwhile parts of Europe were in depression; Japan a liquidity trap; and China aloof to its own fundamental economic and social challenges.
Sound familiar? It should. But don’t just take my word for it. Economists at the Atlanta Federal Reserve struck an eerily similar tone in their blog three days after I penned this section for our quarterly letter (they even applied Mr. Berra’s quote to frame the analysis in the same way).
Entering 2015 the tenor of consensus hummed a comparable tune. And like 2014, we believe that this year’s reality will ultimately stray from the preliminary common view. In the first quarter the U.S. economy took several blows from what appear to be transitory factors. Exceedingly snowy weather snarled supply chains and kept people at home. An appreciating U.S. dollar dented exports. Low energy prices negatively impacted aggregate capital investment. And strife in labor negotiations hobbled west coast ports vital to the smooth flow of commerce.
Despite these problems the American economy remains buttressed by steady job growth, recovering confidence (both business & consumer), improved private sector balance sheets,and upward household consumption – especially once higher savings and lower gas prices take hold. The variables are many, but all told we reason that we’re on a low- to mid-2% GDP growth path.
Overseas, Europe is showing signs of healing. A cocktail of Fed-style quantitative easing from the ECB, a weaker euro, perkier moods, and mending financial conditions have been favorable. If sustainable this would be a clear positive for the global economy. Over in Japan policymakers continue to use stimulative monetary, fiscal, and regulatory measures to jumpstart a soggy economy. In China the regime has taken steps to support a slowing economy, while keeping long-run reforms a priority. Tension in the Middle East remains elevated as various insurgencies and military campaigns create turmoil. Indeed, there are many global risks but for now we don’t anticipate that any will corrode the fundamental reasons we own stocks.
Well functioning financial markets consider (i.e., price in) all relevant information. The result in the January through March period was that broad-based U.S. stock indices were essentially flat. It seems there were just too many crosscurrents for a trend, either up or down, to take hold. In the bond market, yields have generally fallen since the year began. These movements are near parallels to the same period last year.
Valuations investors pay for U.S. stocks were little changed during the quarter. The market as a whole is neither expensive nor cheap at just over 16.5 times earnings expected over the next 12-months. This is a bit above the long-run mean, but in an environment of low interest rates and inflation it’s reasonable. This concept however hasn’t discouraged some observers from expressing concern about overvaluation and bubbles as this bull market enters its 7th year. However neither the economy nor the stock market are at or approaching levels of reckless exuberance. Moreover, studies of longer duration bull markets – those running 5 years or more – suggest that stocks don’t just suddenly decline due to perceptions of overvaluation. In most cases it’s economic recession that ends these entrenched bull market advances. And armed with reams of current economic data, we do not see a recession on the horizon.
Against this backdrop we believe it is appropriate to maintain equity allocations and remain diligent in our efforts to discover and own great companies at reasonable prices. While we are mindful and alert to the world’s risks, the four pillars underpinning a healthy stock market – earnings & the economy, interest rates, inflation, and valuation – endure.
Jason L. Ware, MBA / Deputy Chief Investment Officer
Albion Financial Group