Market Review, Q3 2017Submitted by Karstens Investments on August 7th, 2017
The month of June marks the 10th anniversary of the beginning of the financial crisis, now referred to as the Great Depression. To refresh your memory, June 2007 saw the collapse of two Bear Stearns hedge funds that had speculated in sub-prime mortgages. This event started a chain reaction that included the bankruptcy of Lehman Brothers in September 2008, the near meltdown of the financial system, and a recession that was bigger than anything seen since the Great Depression. Between June 2007 and March 2009, stocks and real estate suffered large losses. It seems strange that the policies put in place to combat the Great Recession still dominate markets to this day. Major governments around the world embarked on a journey to lower interest rates to the lowest level in recorded history, expanded monetary bases (i.e. printed money) at unprecedented levels, and purchased massive amounts of bonds (and in some cases, stocks) pushing interest rates even lower. From an investment standpoint, the policies have created positive results. As you can see on the back page of this newsletter, the 10-year results for
large cap US stocks show an average annualized gain of 7.18%, and US small cap stocks posted an average gain of 6.92%. International stocks have lagged during this 10-year period, though still posted positive returns of 1.03% annually. Keep in mind, these returns are despite the fact that most of these markets lost over one half of their value from 2007 to 2009, the beginning of the 10-year cycle.
The results on the economic side are certainly more mixed. Unemployment rates have come back down to very low levels, although the quality of these jobs and their pay remain in question. Total gross U.S. debt has doubled since 2008, and the total public debt per person has risen from $93,000 to over $155,000 today. Although GDP has risen steadily since 2009, the actual growth rate has been much lower than recorded historically. Perhaps even more important is the fact that while incomes for the wealthy are up substantially, those in the bottom 50% have not grown at all. As we look ahead, it is clear that the Federal Reserve is now working to unwind some of the policies that were put in place to escape the Great Recession.They have taken steps to raise interest rates with three 0.25% rate hikes since December.
They have also clearly stated their intent to begin slowly unwinding the $4.5 trillion dollar balance sheet resulting from the massive bond purchases that were made. Many foreign governments have also either slowed or stopped their easy money policies. Investors fear that the reversal of easy money policies and low interest rates that drove stocks and real estate prices higher will ultimately drive prices lower. In essence, they believe in the old adage, “Don’t ght the Fed.” With stock prices and stock valuations at record levels, some fear is warranted. In this respect, an article in the Financial Times about Jeremy Grantham caught my attention. In the article, Grantham states, “Higher valuations will persist - healthy pro ts, low rates, and lack of euphoria suggest no bubble for Wall Street.”
So, according to Jeremy Grantham, the founder of Asset Manager GMO, and a known bearish spotter of financial bubbles, the stock market has entered an era of higher valuations and probably has further room to rise. The S&P 500’s march to record highs, accompanied by political rancor in Washington, and signs the U.S. economy is failing to kick into a higher gear, has reawakened concerns over equity valuations - especially in the technology sector that has powered much of this year’s rally.
Yet, Mr. Grantham, a notoriously bearish “value investor” who correctly called and dodged the Japanese, dotcom, and hous- ing bubbles, sees little to worry him in the U.S. market today.
Expressing a preference for emerging market equities over U.S. stocks, GMO’s founder points to seemingly durable pillars of healthy corporate pro ts, low interest rates, and any lack of eu- phoria. “I’ve dedicated my life to financial bubbles, and I don’t think it is a bubble,” he told the Financial Times. “This is the broadest market of all time. That is not the nature of a bubble.”
Grantham says, “Higher valuations will persist - healthy pro ts, low rates, and lack of euphoria suggest no bubble for Wall Street.”
Moreover, the normally bearish investor, who has built much of his career on the observation that market levels ultimately tend to revert to their long-term average, has even reluctantly conceded that U.S. share prices may have shifted durably to a higher level since the late 1990s. Whatever your thoughts may be, it is dif cult to argue that we aren’t living in unprecedented times. Trying to prepare for various potential outcomes seems to make the most sense to us.