So here we are. Summer in the U.S. is now unofficially over as Labor Day has come and gone, so it would seem to be a good time to take a step back and review markets in general. We didn’t see much of a summer swoon this year; in fact it has been more of a summer surge. The upward march in U.S. equities continues. The S&P 500 and the Dow Jones Industrial Average are at or around new highs and, while not yet challenging the all time intraday high of 5132.52, the NASDAQ composite is still up over 262 percent from the lows in March of 2009 and around 14 year highs.
It is not just equities that are soaring either. The U.S. 10 year Treasury note seems to be defying logic, with yields holding below 2.5 percent, even as stocks strengthen. For those unfamiliar with bonds I should explain that lower yields equate to higher prices and U.S. Treasuries are generally seen as where money goes when stocks are out of favor, so low yields and soaring equity markets would, by conventional wisdom, be illogical.
Most of us are aware of the reason for this seeming anomaly. Central bank policy has been extraordinarily loose, not just from the Federal Reserve, but also from the Bank of Japan and, increasingly, the ECB. In effect there is a flood of cash and easy credit being pumped into the global economy, and that money, as capital is wont to do, has sought a return, pushing up the price of seemingly everything in financial markets. I have pointed this out many times over the last few years, but it bears saying again as, fundamentally nothing has changed.
Those who point to reductions in QE and the prospect of rate rises in the U.S. next year as a reason for caution will undoubtedly have a point some day, but not yet. The BOJ and ECB are still committed to QE and virtually free money is still globally available to banks, so the conditions that have pushed us to record highs in equities still exist. Given that, as worrying as new highs can be for some, it is hard to see an end to the bull run, at least until next year.
That doesn’t mean, however, that nothing has changed as we hang around the highs. To me, as somebody who searches for value constantly, it is the relative absence of value which forces the biggest change. Inevitably when we get to here, most of the obvious value, either in sectors or individual stocks, has long gone, so the accent has to be more on growth. This shift from value to growth often takes a little imagination.
When a stock represents value it is obvious. Price to Earnings Ratios (P/Es), both trailing and forward are low and we have actual historical data rather than guesses about what the future holds on which to base trades. Evaluating growth potential, though, is much more difficult. As I pointed out last week, At times like this, even sky high P/Es mean nothing. All we are looking for is potential.
There have been a few times earlier this year when I have taken that approach, such as when I talked about the IPOs of GoPro (GPRO) and JD.com (JD), but in general I am more comfortable seeking out value than growth. That will have to change in the coming months.
Nor does the continued general bullishness mean that everything in the garden is rosy. I can see much further to go in these markets, but there are worrying signs that some things have been pushed too far. The low yields on U.S. Treasuries actually make perfect sense in the scenario outlined above. If you, as a financial institution, have the opportunity to borrow from a central bank at essentially zero interest and then lend back to them, risk free, for a return you would be foolish not to do it.
The important part here, though, is risk free. Bund and Treasury yields have dropped, so others have followed as yield becomes at a premium. This has led to a situation that is obviously unsustainable. Just a few short years ago there were legitimate fears that many southern European countries, including Spain, Portugal and Italy, were on the verge of default. The 10 year paper from Spain now yields 2.28%, and from Portugal and Italy 3.18% and 2.44% respectively.
Once again, I have pointed out the dangers inherent in this before as unemployment is still at critical levels in much of southern Europe, but, if anything, the situation is getting worse. Just yesterday, the Spanish government launched a 50 year bond. With all due respect to the wonderful people of Spain and to the EU in general, I think I will decline that opportunity. And continue to keep a watchful eye on the European sovereign bond market. If there is trouble coming, then it would seem most likely to come from that particular bubble, and if the recent collapse in the Euro is anything to go by currency traders feel it may come sooner rather than later.
As we move into the cooler days of fall and prepare for the winter chills nothing much has changed in the major financial markets. Europe still looks to have potential for trouble, but the march to new highs continues, and is set to continue even further. Picking winners has become a little more difficult and will require some guess work, but should still be possible all the same. Until money becomes tighter around the world, then, U.S. stocks are still the place to be.