Markets Mirror Cool Winds of June

The weather in June was cool and rainy in the New York region, and something similar prevailed over the capital and commodity markets last month as well.

As our table below shows, June was a month of mixed messages, ranging from a healthy rally in high-yield bonds to loss in REITs. Disappointing, perhaps, given the previous bout of good times. But the arrival of red ink is hardly unexpected. The March-to-May rally, after all, elevated all the major asset classes by dramatic levels. That couldn’t last. But what comes next?

The optimistic interpretation is that June was a month of backing and filling. The markets are reportedly digesting the recent gains and building a foundation to capitalize on the expected economic recovery. Prices got ahead of themselves in recent months, and bit of profit-taking was inevitable.

A less-forgiving outlook is that the recent rally in almost everything was a sucker’s game. The great bear market of 2008 is still with us, runs this line of thinking, and so the rest of the year will suffer.

Your editor tends to come down in the middle of these two extremes. As we’ve been pointing out in more detail in recent issues of The Beta Investment Report, the foreseeable future for returns in the major asset classes looks increasingly unexceptional. The sharp snapback in prices so far this year looks warranted as it became clear that the worst fears for the economy were overdone. All the more so as it appears that the technical end of the recession may be near.

Then again, we can’t be sure. There are still lots of reasons to remain cautious. Forecasts, after all, are created by mere mortals and so predictions are subject to revisions as new information arrives. Meanwhile, the stock market looks fairly valued at the moment, which is to say that it’s no longer undervalued, as it was as this year opened. Similarly, yield spreads, while still attractive, are no longer extraordinarily high.

In short, the markets have rallied on the expectation that the aggressive liquidity injections of governments around the world would bring stability and, eventually, expansion. That still looks like a good bet, but no longer are markets offering massive discounted prices tied to that outlook.

Then again, none of this is a surprise. Expected returns vary, as they must in order to attract buyers through time. No one would be willing to buy risky assets in January 2009 without an unusually high expected risk premium. Now that the macroeconomic risk looks lower, albeit still substantial, assets are priced accordingly.

Comments

[Prudent Man...:]

When there is a "fundamental" end of the recession I may be able to determine the odds on future value. I would never risk my money on what the market says unless I can back it up with fundamentals. To do otherwise is "The Greater Fool Theory". Hope some learned from 1999 and 2007.

Who can determine when GDP will get back to 2007 levels, if ever, when businesses are incapable of foreseeing the next quarter, politicians continue to change the rules, employment continues to rise, international real estate values are decling and the media is mouthing political and Wall Street propaganda?

I will wait for the Fat Lady to sing on this recession. I rather be late than sorry as well as I being in cash wishing I were in stocks than in stocks wishing I were in cash. When and if the deflation ends things will get interesting.

Jul 01 02:03 PM

[thiazole:]

During a secular bear market, the only good time to invest is right in the middle of the recession. When the fundamental end occurs, the market shortly after goes back to being flat until the next recession hits, and it falls again.


On Jul 01 02:03 PM Prudent Man CFA wrote:

> When there is a "fundamental" end of the recession I may be able
> to determine the odds on future value. I would never risk my money
> on what the market says unless I can back it up with fundamentals.
> To do otherwise is "The Greater Fool Theory". Hope some learned from
> 1999 and 2007.
>
> Who can determine when GDP will get back to 2007 levels, if ever,
> when businesses are incapable of foreseeing the next quarter, politicians
> continue to change the rules, employment continues to rise, international
> real estate values are decling and the media is mouthing political
> and Wall Street propaganda?
>
> I will wait for the Fat Lady to sing on this recession. I rather
> be late than sorry as well as I being in cash wishing I were in stocks
> than in stocks wishing I were in cash. When and if the deflation
> ends things will get interesting.

Jul 01 04:17 PM