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Guy Conger is licensed as an Investment Advisor Representative (IAR) and is licensed to sell and/or discuss Advisory Services & Products with anyone residing within the United States. IAR registration is in: Texas Guy Conger is licensed to sell and/or discuss insurance products only to residents... More
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  • Points To Ponder 0 comments
    Apr 28, 2014 1:07 PM

    Last Week- Following a strong start to the week, the market went up and down for the remainder of the week before selling off on Friday. When the smoke cleared most investors should have seen little change to their portfolios. The aggregate bond index was up by less than 20 basis points while the S&P 500 was down by a fraction. Looking at the individual sectors, utilities continued their outperformance while telecoms were the biggest losers. We are about half way through earnings season with 73% of those reporting beating expectations. However, despite the stronger than expected earnings, of companies that have issued guidance for the second quarter, 70% have guided down, slightly higher than historical trends.

    Potential Bond Bubble - The U.S. bond market totals nearly $40 trillion which is far bigger than the stock market, which stands at about $28 trillion. The bond market is also more tightly linked to monetary policy than the stock market for the simple fact that interest rates affect all types of bonds whereas they don't affect all types of stocks.

    There are three indicators I'm watching that could point to a bubble. First, the rising level of private-sector debt as a percentage of the U.S. economy; Second, narrowing spreads between risk-free Treasuries and corporate bonds; and third, the growing proportion of corporate debt going to riskier companies.

    I feel there is a belief among market participants that the Fed can safely deflate this bubble, but we have to remember what the Fed is currently doing is a grand experiment. Playing around with the economy in an attempt to create growth; While simultaneously keeping an eye on inflation. My fear is that they have overestimated their ability to do either.

    Leaving the Past in the Past- The S&P 500′s current dividend yield is 1.94%, which echoes the interpretation of most other valuation metrics. Stocks are not necessarily expensive relative to their average value over the last 15 years, but are very expensive relative to long term history. In my past remarks about market valuation; I've wondered if this is viable. We might be in a new paradigm for value; but if we are in a new era of structurally higher values, then we have to consider an important result that comes with that.

    If stocks are structurally more expensive than they were in the 20th century, can we expect to receive the same rates of return that we did in that era? If we are leaving the 20th century behind, then maybe we have to leave behind our concept of fair returns on investment. Dividends are one signal telling us to lower our expectations." To get anywhere close to the historical average, stocks would need to fall by half. For argument's sake, we will assume that we are in a new paradigm for stocks where the dividend yield will hover permanently around 2%. What could investors expect in such an environment? It would seem that an investment total return of some 2% or more below the long term average would be in the cards due to the reduced payout percentage

    Bonds don't agree with Stocks -One of the things that I like to look at to get a gauge of the risk appetite out there is the ratio between High-Yield (Junk) Bonds and US Treasury Bonds. If money wants to go to work into risk assets like the US Stock Market, it makes sense that we would see similar action in the bond market. If money is flowing faster into risky Junk rather than the safer Treasuries, then we know that the behavior of the bond market is confirming the new highs in the stock market, Whenever the S&P 500 made new highs last year, the Junk/Treasury spread was also putting in new highs. This inter-market analysis helped confirm what we were seeing in stocks. But so far this year, we're not seeing that confirmation at all. In fact, all we see are lower highs while the S&P hangs out near fresh highs.

    The non-confirmation of junk bonds to the recent rally is a little concerning. Since it reflects the traders belief of economic progress if junk bonds rise versus treasuries the bet is for a better economic performance and vice versa. Of course, the stock market is a forward looking indicator on the health of the economy as well. I have always believed that bond investors are smarter than stock investors, so we will see how this plays out in the coming months.

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