Mid-Year Report 2014 Present: Where we are
Welcome back. In this installment, we’ll take a look at what is happening in the economy now.
The current state of the financial markets can best be highlighted by the following: valuations, spreads, and volatility. Stocks have obviously had a tremendous run from the depths of the recession in March of 2009. The forward price to earnings ratio is currently at about 16. The five, 10, and 35 year average is around 13 to 14. Stocks are trading at a higher than normal price tag for expected earnings. Investors must feel optimistic that corporate earnings growth will accelerate in order to justify these prices. In addition, the market is responding to the fed’s policy to maintain interest rates at these historically low levels. As a result, stocks seem to be the more viable investment with bond yields offering dangerously low yields.
Slow economic growth, strong demand, subdued supply, low inflation, and geopolitical uncertainty pushed interest rates lower in the quarter. On a quest for yield, investors drove high yield debt spreads lower and absolute yields below 5% for only the second time in history, as shown in this chart. Even with junk bond defaults running at about 2%, this paltry absolute yield provides little buffer should markets grow concerned about the economic outlook.
The markets have been plagued with volatility since the last recession. Uncertainty was rampant as investors were confronted with unprecedented activity. Things have since calmed down, sending volatility indices plummeting. Now, some skeptics are saying complacency is a new risk in the markets. But you can’t have it both ways. Volatility is either risk or it’s not. When people were complaining about excessive volatility in the markets post recession, everyone hoped for exactly what we’ve received. A dose of calm, and more normal trading behavior.
Now that we’ve discussed the past and present, our next video will explore future expectations.