In a recent interview, Dr. Marc Faber, the author and publisher of the Gloom Boom and Doom report, talked about his near-term gloomy outlook for equities. This article discusses his views and lays down further reasons to remain cautious on equities in the near-term.
According to Faber -
What was the trigger of the '87 crash when markets fell 21 per cent in one day? What was the trigger of the Nasdaq crash in 2000? What was the trigger of Japanese crash of 1989? What was trigger of 2007 crash that brought global stocks down 50 per cent? We don't know these things ahead of time, but something will always move markets up and something will always move them down. I would guess at the present time, given markets from the 2009 lows have in many cases increased by as much as 100 per cent, that they are no longer very cheap. .... Something could come along, geopolitically or otherwise. I would be very careful being overweight equities. I still have 25 per cent in equities and 25 per cent in corporate bonds... In the 40 years I've been working as an economist and investor, I have never seen such a disconnect between the asset market and the economic reality ... Asset markets are in the sky and the economy of the ordinary people is in the dumps, where their real incomes adjusted for inflation are going down and asset markets are going up...Something will break very bad ...
My Opinion -
There is no doubt that there is a great disconnect between the asset markets and the real economy. In one of my recent articles, I discussed the real unemployment scenario in the United States and it just underscores the point that the real economy is very weak.
Also, the Fed's expansionary monetary policies have benefited banks and financial institutions. It has also helped inflate asset classes. However, with banks going conservative on lending to consumers, the positive impact of the Fed's policy for households is minimal. I had discussed the futility of current monetary policies in another of my earlier articles.
Leaving aside the economy, the equity market valuation also looks stretched. At this point of time, fresh exposure to equities can be suicidal. The S&P (SPY) is currently trading at a PEG of 1.4. This is expensive considering the point that future growth can be relatively depressing as global economic activity remains sluggish.
Another very critical factor, which should make investors think twice before investing at current levels, is the amount of speculation in the markets. According to the NYX data, the margin debt for March 2013 was at $379 billion, which is among the highest levels in the last 13 years. A high margin debt does indicate rising optimism and speculation. Amidst this, investors will be better off waiting in the sidelines and considering exposure to equities on correction than at these levels.
If the rising concern on Fed's exit comes true, markets will have another reason to correct over the next 3-6 months. The markets are currently addicted to artificially low interest rates and easy money. Therefore, if the Fed does decide to curtail its bond buying program, the markets are likely to react negatively. I must add here that if markets correct by 15-20%, the policymakers will again be back in action. Long-term investors therefore can hold on to their positions.
In terms of portfolio diversification, I would convert 20-25% of my portfolio in cash or medium-term government bonds at this point of time. As mentioned by Faber in the interview, a 20-25% exposure to gold would be a good idea. I would also consider silver in my portfolio of precious metals. The remaining allocation can be towards equities, corporate bonds and real estate. It is worth mentioning here that the rental yields in the United States are attractive and buying property is a good idea at a time when home ownership in the US is at a record low level.
Investment Conclusions -
In a market driven by liquidity, speculation and optimism, it is difficult to talk about intermediate market tops. I am bearish on the markets at current levels. However, investors can't rule out another 5-10% surge in the markets from current levels. Investors however need to exercise caution than greed at these levels and stay on the sidelines with cash. The next 3-6 months will certainly give some very attractive investment opportunities. On any steep market correction, the following investments can be considered -
SPDR S&P 500 ETF - It has been proven that beating the index is not an easy task. Therefore, the strategy should be simple -- beat the index or invest in the index. From this perspective, SPY looks interesting. The ETF provides investment results that, before expenses, generally correspond to the price and yield performance of the S&P 500 Index.
SPDR Gold Shares (GLD) - The investment seeks to replicate the performance, net of expenses, of the price of gold bullion. After the current correction, gold does look attractive for long-term and can be considered as an integral part of a well diversified portfolio.
Vanguard Energy ETF (VDE) - The ETF seeks to track the performance of a benchmark index that measures the investment return of stocks in the energy sector. With a low expense ratio of 0.19%, the ETF is a good investment option in a sector, which has good upside potential in the long term considering incremental demand from Asia and continued expansionary monetary policies.
iShares MSCI Emerging Markets ETF (EEM) - The iShares ETF corresponds generally to the price and yield performance, before fees and expenses, of publicly traded securities in emerging markets, as represented by the MSCI Emerging Markets Index. It is important to diversity the portfolio to emerging markets as the EMs have the potential to significantly outperform developed markets in the long term.
Johnson & Johnson (JNJ) - Among individual stocks, JNJ is a good investment option. I like this highly diversified healthcare company, with products as well as regional diversification. Further, the sector catered to by JNJ is not very prone to economic shocks. JNJ has been a good dividend payer in the past, with a dividend yield of 3.1%. In my opinion, the stock is excellent for a long-term portfolio. It also commands a higher rating than the U.S. sovereign rating.