Old newspapers are a good source for learning about the history of the financial market, as they can provide insights about the current financial market. I recently came across this paragraph from an old CNN report from Dec, 31, 1999 which highlighted that, "...U.S. economy is poised to record the longest expansion in history...But despite the headlines about records...," only few investors of high-tech or telecom stocks came out as winners. The article pointed out that, "...most investors did not love 1999."
If we take a look at the table below, even though the Russell 3000 Index is relatively flat year-to-date in 2015, the majority of the companies comprising the Index have deteriorated, just like in 1999. From a technical analysis point of view, this is a sign of weakness.
This week’s chart shows that investment-grade credit spreads have widened this year, even though the S&P 500 Index went nowhere. In the last six years, leveraging on cheap debt and buying back shares has been a popular way for companies to boost earnings per shares (EPS). The benefit of higher EPS goes to equity holders because stocks trade with EPS; the price paid goes to bond holders because bonds trade with the balance sheet. After six years of buybacks, recent Goldman Sachs research shows the Aggregate corporate Net Debt/EBITDA (earnings before interest, taxes, depreciation and amortization) is at 1.6x, higher than the 1.4x in 2008. This increase in balance sheet leverage will eventually slow share buybacks; other drivers of earnings growth are slowly beginning to turn as well.
Low financing cost has been a driver for corporate earnings. This driver will slowly go away when interest rates starts to rise. Low wage growth is another driver for earnings; however, in the last quarter, we are hearing more and more companies raising wages, such as Chipotle Mexican Grill, Wal-Mart, Starbucks, HCA Holdings and Target, to name a few ( average hourly earnings released on November 6 also confirms this). At this phase of the economic cycle, I would expect to see more wage pressure, which is something I am monitoring closely. The last major driver is foreign sales. Between 2009 and 2011, foreign sales have been a bright spot for U.S. corporations because of higher growth overseas and a weaker dollar. We have now seen a reversal of this trend.
Key Takeaway: All this supports taking a cautious stance in the market; however, before we see the price and volume confirmation, we should be careful not to turn too bearish. The market has shown impressive resilience despite a potential interest rate increase, ISIS terrorist attacks, weak data from China and a relentless selloff in commodities. If I have to guess, my feeling is that plenty of investors see what I see and are taking a cautious or bearish stance in the market. When everybody is cautious, grinding higher becomes the pain trade, and this is what we are seeing in the market.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
Opinions and statements of financial market trends that are based on current market conditions constitute judgment of the author and are subject to change without notice. The information and opinions contained in this material are derived from sources deemed to be reliable but should not be assumed to be accurate or complete. Statements that reflect projections or expectations of future financial or economic performance of the markets may be considered forward-looking statements. Actual results may differ significantly. Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate.
Investing involves risk, including possible loss of principal. Past performance is no guarantee of future results. All information referenced in preparation of this material has been obtained from sources believed to be reliable, but accuracy and completeness are not guaranteed. There is no representation or warranty as to the accuracy of the information and Penn Mutual Asset Management shall have no liability for decisions based upon such information.
High-Yield bonds are subject to greater fluctuations in value and risk of loss of income and principal. Investing in higher yielding, lower rated corporate bonds have a greater risk of price fluctuations and loss of principal and income than U.S. Treasury bonds and bills. Government securities offer a higher degree of safety and are guaranteed as to the timely payment of principal and interest if held to maturity.
All trademarks are the property of their respective owners. This material may not be reproduced in whole or in part in any form, or referred to in any other publication, without express written permission.
