Notes from the Investment Committee
|Index Name||PE Ratio||1/31 Close|
|Russell 2000||29.5x EPS||1,394.52|
|Wilshire 5000||26.3x EPS||24,689.93|
|10 Year Treasury||2.46%|
|13 Week T-Bill||0.53%|
What was expensive two weeks ago remains expensive as the markets continue their march higher, whether you’re looking at valuations using the CAPE ratio, GDP to market cap or even on rosy forward earnings. Right now, the expected EPS growth for 2017 is predicted to be over 15%, with much of those gains coming from the energy and technology sector. Valuations in other parts of the US markets are also elevated, with small and midcap sectors well over 25x EPS. What is striking about today versus the “bubble” periods of ’00 and ’07 is that the median stock is more overvalued than in the past.
Interest rates have moved up from year ago levels, but are flat over the past month. Comments from the Fed, both on the speaking circuit and in front of Congress, makes it seem as though they are willing to raise rates sooner rather than later. Interestingly though, long-term rates have not moved on that news. The recent inflation data supports higher interest rates.
While the economic data is stronger than expected, evidence shows there is some “seasonality” to the expectations. Coming into the year, expectations are modest (and the data better). By mid-year, those expectations have been increased (and the data worse). Finally, by year-end those expectations begin to decline (and the data better). This annual cycle may also play a part in the movement of GDP estimates as well as earnings expectations. On the sunny side were better retail figures, higher credit growth and inflation data. Industrial production remains weak, housing expectations are moderating and business credit growth is at slowest pace in 2 years. Overall the data does not point to heightened recessionary fears. That remains well off in the future.
Monetary policy in the US is moving very differently than that of central banks around the world. We expect rates to rise in the US, while Japan and Europe continue moving along their own QE policy. The upshot is that the dollar is likely to remain relatively strong, which could hurt international trade. It remains a very rough balancing act between moderating monetary policy and strong economic growth.
For all the hand-wringing about market valuations, the short-term technical condition of the markets remains relatively strong. Stocks making new highs remain above 400 on a weekly basis, while those making new lows have been below 50. The advance/decline line remains moving northwest, supportive of stock prices. The steady increase in the markets since the election makes it easy to wait for a correction before committing funds. However, the nature of the gains has not happened overnight, but during the regular trading day, meaning investors are buying throughout the day. Of course, a market correction of 3-5% can happen, but at this point it is our expectation that any decline could/should be met with buying.