If we put hope and wishful thinking aside and look at what the economic and corporate data tells us, the U.S. economy is flirting with recession and markets are due for a bear market correction of 30-50%. The U.S. and global economies are growing more slowly than forecasted just a few months ago. Data indicates that instead of getting stronger, macro trends are getting weaker.
U.S. Corporate operating earnings are already in recession, which should be obvious to investors, as 1st quarter reports once again confirm broad weakness. Markets typically fall as negative earnings trends are confirmed, as they did in 2000 and 2007, which both lead to markets following earnings lower into significant bear market sell offs. Yet the market continues to trade near all-time highs while sporting a historically high 24x trailing price to earnings multiple (P/E).
In late 1999 the trailing P/E on the S&P was even higher at 30x just before the Dot Com bubble burst, which is less than reassuring because the S&P fell 50% over the following couple of years.
We are not rooting for a bear market, far from it, but that is what the data and market valuations indicate based on historical norms. What’s different this time is the level and prolonged nature of central bank monetary intervention. People have generally believed that central bank policies will provide the necessary cure for the economic ailments we see globally. And even as indicators are flashing warning signs of continued economic slowdown worldwide, investors still seem to want to believe that central bankers will be able to throw some more monetary policy “fairy dust” into the mix to pull us out of a potential deflationary quagmire.
Unfortunately, central bank “fairy dust” is running out of power. Monetary stimulus is a short-term tool typically applied to jump start economic activity following a recession. It is not a particularly good long-term solution because the incremental benefits provide diminishing returns for each stimulus dollar. Historically monetary policy is paired with fiscal stimulus, the appropriate long-term stimulus tool, which picks up as monetary policy benefits fall off. It seems clear the world is in dire need of fiscal stimulus not more monetary intervention.
While the math of the market paints a gloomy picture, there seems to be a growing consensus in the media and by both candidates on the stump that fiscal stimulus is a solution to global economic malaise. This should increase the odds that politicians will yield to populous pressure and take positive action, hopefully sooner than later. This would be good news, because a proper measure of fiscal stimulus should push domestic economic growth rates up quickly giving us the kind of GDP growth needed to reverse negative corporate revenue and earnings trends. This will add fuel to fire, igniting what could become a very high quality bull market cycle. In the meantime, investors have shifted their preference back to value and dividends after favoring growth and momentum stocks. By far the steadier bet in volatile markets, value stocks may provide a little “fairy dust” of their own to beleaguered portfolio returns.
The views above are those of Don Schreiber, Jr. and should not be construed as investment advice. All economic and performance information is historical and not indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for a specific portfolio. Moreover, you should not assume that any discussion or information provided here serves as the receipt of, or as a substitute for, individualized investment advice from WBI. To the extent that you have any questions regarding the applicability of any specific issue discussed to your client’s individual situation(s), you are encouraged to consult with WBI. All information is obtained from sources believed to be reliable, but WBI does not guarantee its reliability.
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