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posted on 15 July 2017

Interesting Tidbits

Written by , Clarity Financial

I ran across a couple of interesting tidbits this past week that I thought were worth sharing with you. The first point comes with reference to my comments over the last couple of weeks of algorithms kicking in to buy every dip. In fact, they now appear to be hitting the “button" faster than ever.


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To wit:

“For dip-buyers in the S&P 500, 2017 has actually been a tough year… because there hasn’t been any. As JPMorgan notes, 2017’s 3% intra-year decline is the smallest since 1980 (tied with 1995 which saw a 34% return)"

“This 3% drawdown (for now), continues a 6-year streak of drawdowns that are dramatically below the longer-term average of 14.1% drops intra-year."

The question is what happens when the Federal Reserves quits injecting capital into the market through reinvestment and begins to allow their balance sheet to reduce? As I have noted previously, there is a very high correlation between those reinvestments and subsequent market action.

Secondly, the Fed has suddenly become concerned about valuation pressures. This is interesting given the Fed has not given valuations much concern previously suggesting the “low interest rates supported higher valuations."

However, in the most recent release of their Monetary Policy Report for July, it was noted:

Valuation pressures across a range of assets and several indicators of investor risk appetite have increased further since mid-February. However, these developments in asset markets have not been accompanied by increased leverage in the financial sector, according to available metrics, or increased borrowing in the nonfinancial sector. Household debt as a share of GDP continues to be subdued, and debt owed by nonfinancial businesses, although elevated, has been either flat or falling in the past two years."

I am not sure exactly what debt metrics she’s looking at, but leverage is currently at the highest level on record.

Furthermore, even looking at the S&P 500, 400, 600 and Russell 2000 indices based on FORWARD OPERATING earnings estimates 2-YEARS into the future, I simply could not find a more generous measure of valuation, stocks are expensive. If EPS estimates fail to meet future expectations (which they always do) valuations will increase further.

Are stocks expensive? Yes.

Are companies and individuals heavily leveraged? You bet.

Will the outcome be benign? Probably not.

Lastly, while the “jobs report" was decent on Friday, with the exception of wage growth, it is important to remember two things:

  1. The employment report, along with all economic reports, are subject to heavy backward revisions, and;
  2. The “trend" is far more important than the actual number.

In regards to point 1) - the corporate tax receipts through April contracted the most since 2009. This suggests the macro corporate environment is weaker than currently believed and hiring generally does not “ramp up," outside of temporary factors, if the overall environment is weak.

As to point 2), it should not come as a surprise the trend of employment has clearly begun to weaken. This has historically coincided with the Federal Reserve starting a rate hiking campaign which tightens monetary policy. Why everyone believes this time is different is beyond me?

As Dr. Lacy Hunt recently stated:

“When the Fed tightens, they are saying the economy is doing too well by our standards… we want the economy to have less money and credit growth and we want less economic activity. They are saying this at a time when the best economic indicators are in a downturn.’’

The Fed has likely got it wrong…again.

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