Equity valuations and higher bond yields

Market meltup was the buzz word of asset managers until recent days.

This is hardly surprising considering that shares on Wall Street and especially, Germany, France, Italy and even Greece surged in the second half of the year. The big question following a bull market that began during the gloomy month of March 2009, when the investment crowd was pessimistic, is what investors do now?  Participants are aware that the steeper the market cliff, the deeper the ultimate ravine, especially in the current uncertain global economic and political environment. The Chart illustrates the dangers of  buying in aging bull markets. To be sure, there was a mega bull market from 1982 that  crashed in 1987, rallied in 1988 and then took off in the late nineties. A slump followed. A renewed 2002 to 2007 market surge and the subsequent crash of 2008/2009 turned into the current bull market that has soared by 159 percent from its 2009 low of 683 points. Indeed the pattern of up and down bull and bear markets from 1969 to the nadir in 1982 was similar to the fluctuations in the past 16 years.

Guggenheim Partners’ Global Chief Investment Officer Scott Minerd recently spelt out the mood and dilemma: “There remains significant upside for risk assets, but in this liquidity-driven market there is also an increasing risk of a ‘melt-up’ such as the one that preceded the bursting of the tech bubble in early 2000”.

“Combined with seasonal factors, excessive Fed-driven liquidity is providing a green light for risk assets in the United States, and even more so, internationally,” he added. “Waves such as this only last so long before crashing, and as anyone who is familiar with surfing knows, you better get off the wave before it reaches the shore. Today, the shore appears a long way off, but it is there and should still be considered as investors formulate their strategies.”

Traders also note that hedge fund managers and other players who had sold short on expectations that prices would fall, have been forced to cover. By repurchasing stocks at higher and higher prices, their buying also fuelled the flurry.

From a global standpoint, Asian and other emerging market investors have already experienced a crashing wave during the second quarter of this year. Their markets began to recover in the third quarter when surprise, surprise, the vast majority of participants were negative. For American and European investors and traders, the 2011 sharp correction in the almost five year bull market appears to be a distant memory.

What is a prudent policy? In an aging bull market investors could follow the precepts of experienced traders who apply strict disciplines. The classic rules are stop loss orders  and target price levels. If a share falls by 5 to 10 percent for example, traders cut their losses and if the price reaches a valuation target, they sell. Others follow momentum of the market, holding their stocks in an uptrend, but selling them if the price rises too far above a moving average or if it breaks and falls below it. High frequency funds have built in sophisticated models following these various technical and fundamental signals. Their actions cause volatile markets that bring down good shares with the bad and vice versa. The result is frustration, but also opportunities for shrewd investors. (See simple explanation for all in chapter six of Trader Jack ).

The real dilemma applies to investors who mistrusted the consequences of Fed chairman Ben Bernanke’s quantitative easing (QE) suppression of interest rates. Some kept funds in bonds or in cash; others sold a portion or most of their equity holdings too soon. The cliché is that the market swings between fear and greed but another way of looking at investors’ psyches is the “fear of losing out”. This appears to be a major behavioural reason for latecomer retail investors have belatedly invested in funds. When that happens, the flows land in the coffers of asset managers and some of them pile into stocks without carrying out adequate research.

The valuation table (below) illustrates that global markets, with the exception of relatively opaque and poor governance markets in China and Russia, have become relatively expensive, despite the claims of super bulls. Bonds are rising and falling because of market forces as multi-trillions of holdings are far larger than Fed purchases. American fund managers in recent months have thrown money at European shares. Relative to the risk in shaky Eurozone and other countries, these markets can hardly be described as attractive at current levels.

Neil Behrmann is author of Trader Jack-The Story of Jack Miner

©Neil Behrmann – All Rights Reserved

         Comparative Global market valuations   December 2013
  Stock   index change since Dec 2012 % (local currency to November 30) Earnings   yield% Dividend   yield% 10 year   bond yield%
Developed   Markets
Japan Nikkei +49.3 6.2 1.7 0.69
US S&P 500 +27.4 5.6 2.3 2.87
Spain +15.7 5.6 4.2 4.11
Switzerland +16.6 5.3 2.8 0.98
Germany +19.2 6.6 2.8 1.83
Italy +10.5 5.3 3.3 4.09
France +12.2 5.6 3.1 2.31
Australia +9.5 5.7 4.3 4.30
UK +10.3 7.2 3.3 2.90
Canada +5.6 5.6 3.0 2.66
Emerging   Markets
 South   Africa +13.2 6.0 3.3 7.85
 Indonesia -1.0 6.3 2.7 8.63
Malaysia +9.1 6.1 2.9 4.06
 Thailand -1.6 7.1 3.3 4.02
Singapore -3.4 8.1 3.0 2.46
 India +9.0 6.7 1.7 8.91
Hong Kong +3.0 8.5 2.9 2.30
 Korea -1.0 6.5 1.1 3.63
Russia -1.0 18.2 3.5 7.72
China -3.0 13.7 4.3 4.65
Brazil -17.9 7.1 3.8 12.80
Source: Economist, ThomsonReuters, Trading   Economics



















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