The Context of Price

While the stock market has enjoyed a recent rally, some investors are experiencing some “weakness in the knees” as they continue to ascend the climb. These new all-time highs in the market compound the problem for some investors as they suffer from the recency effect, or the not-too-distant memory of significant market losses. As Anatole Kaletsky of GaveKal points out, the market has now surpassed the year-2000 highs by 10%. This is a rare event and he suggests that it is “only the fourth time in 100 years that a high, which had remained unbroken for more than four years, was exceeded by 10%.” 1 In each such case, the “event confirmed a major multi-year bull market.” 2 Kaletsky believes that this implies a “significant change in investor perceptions, which in turn will affect economic reality.”3 Essentially, we are now in a secular bull market for equities. Since 1950, equity price-to-earnings (P/E) multiples have been “consistently and logically higher” than the P/E of investment-grade bonds, according to market strategist Thomas Lee at JPMorgan.4 However, at today’s fixed income rates, the implied P/E (or the inverse of the bond yield) is much higher. As Lee states, companies “are the ultimate payer of both bonds and equities and, thus, over time, the multiples between the two should be reflective of fundamentals, not liquidity preference.”5 As coupons are fixed and “equity earnings grow over time, the P/E of a stock should be higher than the P/E of a bond.”6 As rates move up in the future, I would expect the historical P/E relationship to normalize, which would be favorable for equities. As Hedgeye Risk Management recently wrote, “a normalization in interest rates shouldn’t serve as a material headwind to consumption growth or equity market performance.” 7

Although the equity markets have rallied here in the U.S., emerging markets have especially been under pressure recently. Paul Krake, from a View From the Peak, maintains that the strong dollar has not helped “emerging market credit cycles,” as it is “not good for commodities.”8 Furthermore, emerging markets will have to compete with energy independence in the U.S. and new technologies like 3D printing that “has the potential to absolutely crush the Asian manufacturing base over the next 20 years.”9 Furthermore, Krake adds that while the Fed will keep cash rates at zero for some time, “there is a growing and alarming trend of emerging market economies using rising interest rates as a vehicle to support [their] flailing currencies. This in itself should assure further EM equity underperformance.”10 Retail investors here in the U.S. usually gain exposure to emerging markets via exchange traded funds (or ETFs). Roger Wohlner, from the Chicago Financial Planner, recently highlighted that the liquidity of some ETFs has suffered in times of market stress. For example, just over the past two months, there have been “some fairly wide spreads between the underlying net asset value and the market price of some emerging market ETFs. This is in large part a function of a lack of liquidity of the underlying holdings of these ETFs.”11 The Financial Times also added that “the global sell-off last month sparked the highest amount of settlement failures in parts of the $2tn exchange-traded fund market in nearly two years, reviving a debate over whether the popular investment vehicles suffer from structural issues that flare up in times of market stress.”12 In recent years, the prevalence of ETFs has left many retail investors exposed to these liquidity issues as all ETFs are not created equal. As Raymond James strategist Jeffery Saut has said, “Regrettably, most of us can’t think on the margin, which is why the crowd tends to “move” long after the optimum time to “move” has passed.” Simply, some investors are not earning an appropriate return to account for the liquidity risk inherent in some of these products, which may lead to undue downward price pressure in times of stress. Per Howard Marks of Oaktree Capital, “One of my constant themes is that there is no such thing as a good idea other than in the context of price.”

Pamela Rosenau, Managing Director and Chief Equity Market Strategist at HighTower and Chief Investment Officer at the Rosenau Group has over 25 years of experience in the financial industry. Ms. Rosenau focuses on strategic and tactical asset allocation, investment planning strategies and equity portfolio management strategies. As a result of her extensive knowledge and expertise in the equity markets, she was named the Equity Market Strategist for HighTower. In addition to this role, she performs due diligence on the firm's third party research relationships and continues to add, monitor, and prune research providers where necessary. Prior to joining HighTower she worked for various sell-side firms beginning her tenure at Wertheim & Co./Schroders Plc.

Ms. Rosenau was recently ranked #14 in Barron's 2013 Top 100 Women Financial Advisors. She was also chosen for Barron's 2013 Top 1,000 Advisors list, ranking #42 out of all financial advisors in California. Ms. Rosenau holds series 7, 63, and 65 licenses.

The Rosenau Group is a team of investment professionals registered with HighTower Securities, LLC, member FINRA, MSRB and SIPC & HighTower Advisors, LLC, a registered investment advisor with the SEC. All securities are offered through HighTower Securities, LLC and advisory services are offered through HighTower Advisors, LLC.

This document was created for informational purposes only; the opinions expressed are solely those of the author, and do not represent those of HighTower Advisors, LLC or any of its affiliates. In preparing these materials, we have relied upon and assumed without independent verifications, the accuracy and completeness of all information available from public and internal sources. HighTower shall not in any way be liable for claims and make no expressed or implied representations or warranties as to their accuracy or completeness or for statements or errors contained in or omissions from them.

This is not an offer to buy or sell securities. No investment process is free of risk and there is no guarantee that the investment process described herein will be profitable. Investors may lose all of their investments. Past performance is not indicative of current or future performance and is not a guarantee. Carefully consider investment objectives, risk factors and charges and expenses before investing.

1 Anatole Kaletsky. Gavekal. Good Omens. July 15, 2013.

2 Ibid.

3 Ibid.

4 Thomas J Lee. JP Morgan. US Equity Strategy Flash. July 25, 2013.

5 Ibid.

6 Ibid.

7 Hedgeye Risk Management. Q3 2013 Macro Themes. July 24, 2013.

8 Kate Welling. Welling On Wall Street. Keeping it Simple. July 12, 2013.

9 Ibid.

10 Paul Krake. View From the Peak. July 18, 2013.

11 Roger Wohlner. Chicago Financial Planner. July 17, 2013.

12 Tracy Alloway and Arash Massoudi. The Financial Times. July 24, 2013.

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