By Veronica A. Fulton, Research Analyst – GLOBALT Investments
“It is easy enough to burst a bubble. To incise it with a needle so that it subsides gradually is an operation of undoubted delicacy.” – John Kenneth Galbraith
We find ourselves wanting to use the words “most”, “ever”, or “all time” when we want to quantify the magnitude of extremes we are seeing within the market and economy. Despite these extreme levels of divergence, high valuations, and unprecedented monetary and fiscal intervention, our diligent and cautious approach allows us to navigate any market environment.
Market & Economy
Underneath the surface, the market is narrowing. The S&P 500, Dow Jones, and Nasdaq each posted all-time highs recently. Yet indicators such as the high-low index and advance decline line show mixed breadth with a small group of stocks driving the performance. Fundamentally, growth stocks should outperform value stocks in this low interest rate environment. This has not been the case for small-cap, with the Russell 2000 Value up over 25% and small cap growth, as measured by the Russell 2000 Growth, up only 1.5% for the year. In comparison, large cap growth is up over 27% (as of). If both growth indices were to finish off the year right here, it would be the largest divergence in annual performance between the two since 1998. Employment data appears mixed as well. The November jobs number as measured by the household survey added 1.14 million workers, a number not seen since last year, and prior to that 1990! However, the establishment survey came in below consensus, adding only 210,000 for the month. Divergences between the two surveys can occur; however, one of this magnitude is not common.
Implications of Inflation
The total U.S. equity market value relative to gross domestic income (a proxy for economic value) is well beyond its trend level as quantitative easing allowed the market to outpace the economy. Corporations have managed to soak up the liquidity and pass the inflation costs to consumers in order to grow profit margins to levels not seen since 1950. Despite the huge gains for companies, wages as a percentage of company earnings are at an all-time low, and real wages are steadily decreasing with each incremental increase in inflation. Economic data consistently shows that prices are rising more quickly and for a greater length of time than previously anticipated. As a result, the CPI rose to a 6.8% year over year increase, its fastest pace in nearly 40 years, while the real Fed funds rate has reached -6.14%, the most negative it has been since the 1970s. These levels have become more concerning for both investors and the Fed as they no longer appear “transitory”.
Despite apparent distortions and sticky inflation, investors are all in. Cash as a percentage of investor’s total asset allocation is at historically low levels and margin debt is at record highs , implying both speculation and leverage are at paramount levels. Simply put, this market continues to inflate notwithstanding the huge amount of structural risk, and there appears to be nothing other than ultra-low rates and liquidity injections to support it. These extremes, accompanied by the recent spike in volatility, lead us to believe this Fed-induced bubble has become even more fragile than before. Given the current environment and its unforeseeable future, we are reminded of similar bouts in history and the origins of our asset allocation strategy. When faced with uncertainty, divergence, narrowness, and a lot of “never before seen” phenomenon, managing risks through diversification becomes important to capital preservation.
Sources: Ned Davis Research, Bloomberg, Wolfe Research, MarketWatch.com
GLOBALT is an SEC Registered Investment Adviser since 1991 and, effective July 10, 2013, remains a Registered Investment Adviser through a separately identifiable division of Synovus Trust N.A., a nationally chartered trust company. This information has been prepared for educational purposes only, as general information and should not be considered a solicitation for the purchase or sale of any security. This does not constitute legal or professional advice, and is not tailored to the investment needs of any specific investor. Registration of an investment adviser does not imply any certain level of skill or training. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information may be required to make informed investment decisions, based on your individual investment objectives and suitability specifications. Investors should seek tailored advice and should understand that statements regarding future prospects of the financial market may not be realized, as past performance does not guarantee and/or is not indicative of future results. Content may not be reproduced, distributed, or transmitted in whole or in part by any means without written permission from GLOBALT. Regarding permission, as well as to receive a copy of GLOBALT’s Form ADV Part 2 and Part 3, contact GLOBALT’s Chief Compliance Officer, 3400 Overton Park Drive, Suite 200, Atlanta GA 30339. You can obtain more information about GLOBALT Investments and its advisers via the Internet at adviserinfo.sec.gov, sponsored by the U.S. Securities and Exchange Commission.
The opinions and some comments contained herein reflect the judgment of the author, as of the date noted.
Investment products and services provided are offered through Synovus Securities, Inc. (SSI), a registered Broker-Dealer, member FINRA/SIPC and SEC Registered Investment Adviser, Synovus Trust Company, N.A. (STC), Creative Financial Group, a division of SSI. Trust services for Synovus are provided by STC.
Regarding the products and services provided by GLOBALT:
NOT A DEPOSIT. NOT FDIC INSURED. NOT GUARANTEED BY THE BANK. MAY LOSE VALUE. NOT INSURED BY ANY FEDERAL AGENCY