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Comments on recent market events

Perspective is important to maintaining a clear head in face of market turbulence.

Below is a picture of the last 6 months price performance of VTI (in green), Vanguard Total U.S. Stock Market, which represents approximately 95% of the tradable US equity market. We added BIL (orange) , SPDR 1-3 Month T-Bill ETF (0.2yr) which tracks short term Treasury bills, and VEU (blue), Vanguard FTSE All-World ex-US, a proxy for all non-US equities.

You can see the decline of VTI of about -5.6% over the last 6 months and -8.5% for VEU. Not a good or pleasant thing.

 But also consider the longer term perspective.

We’ve had a huge bull run from March 2009 to Aug 15, 2015. Take a look at the total returns below (which include price & reinvestment of dividends or interest).

But here’s the fine print that we always need to recall: you don’t get equity returns without equity risk.  

And you can see it in the absolute price movement, volatility (below as the annualized standard deviation of price) and Drawdown (represents the largest % decline from the maximum to minimum of daily prices over the same period).

We've seen a correction, it is unpleasant, and there may be a bit more to go depending on the next catalyst.

 In our last quarterly commentary we noted the disconnect between productivity and the equity prices and commented:

“We sense multiples may contract as 1) a natural response to the long bull run of the equity markets and currently fulsome valuations 2) in anticipation of rising interest rates in the US or 3) a response to particular events of geopolitical conflict.

We also noted our expectation of the Fed raising short rates by .25% “unless the economy completely stalls”. Europe, China and the emerging markets might now fit that description. There will be spillover to the US, and we now believe the Fed hike will likely be shelved... at least until commodity prices stabilize a bit or possibly until after the election.

Our expectation is that US corporate earnings will be ok this year but will become less robust over time. Exports are going to be hurt by the US$ strength. 

  • Earnings Scorecard - “ Of the 436 companies that have reported earnings to date for Q2 2015, 73% have reported earnings above the mean estimate and 51% have reported sales above the mean estimate.”
  • Earnings Growth - “the blended earnings decline is 1.0%. The last time the index reported a year-over-year decrease in earnings was Q3 2012 (-1.0%).”   FactSet Aug 6.

We look for 1-2% GDP this year. Some, but not us, expect a slight acceleration as high as 3.5% in the second half. That would be a good thing, but we’re not buying it.

The US consumer may get some relief in energy costs with oil now about $40/barrel, although, ObamaCare will eat away at that benefit which would otherwise be a huge stimulus to the entire economy... but he’s not interested in wealth creation, only its transfer.

The bond markets still have a positive yield curve with 10 year less 2 year spreads still relatively normal. Bear in mind we’ve never had a recession without some foretelling by a negative yield curve. So from our perspective this is about growth, multiple contraction, and perception of risk. The risk premium just got raised, Mr. President and Ms. Yellen.

Readers of our commentaries this year know we’re not going to engage in a lot of happy talk. This recent market is unpleasant, and it may not be over yet. The fact is no one knows. We do know that this is what extended bull markets do.

There is also a political element to the extant economic issues & risks we face. There is a genuine sense that some big things are wrong with our policies, our leadership, and their manner of comportment, but the apparent degree of support for populist, wrong headed remedies such as trade restraints, trade wars, US $ devaluations is making people, including us, very nervous.

The world is not ending, but rather repricing, and the market tends to reprice to value. Consider: XOM, perhaps the best managed company in the world, is now selling at a a P/E of 12.8 and yields 4.05%. Some would say its cheap, and many other good companies may join the crowd. At some point the markets start to buy. That is what rebalancing does.



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