In early 2011, the head of research at a leading investment bank predicted we were entering a sideways market. He was right, for about 6 months before the market fell sharply and then proceeded to almost double.
So far in 2015 we’ve been in a sideways market with different sectors providing leadership in a strange game of musical chairs.
On an absolute basis, the S&P (i.e., the "market") appears over-valued at around 18x forward earnings.
Yet on a relative basis, the valuation seems attractive compared to the risk-free 10-year treasury yield of 2.3%. But what happens to the "relative" argument when the risk-free rate moves up with the “flick of a pen” (i.e. when the Fed raises rates)?
The bulls point to strong job growth as signs of an improving economy which should fuel the next leg of equity returns.
But there are alarming trends
- In a recent Forbes article we said unless we get earnings growth driven by some kind of fiscal policy (e.g., infrastructure spend), we risk entering a bear market (if we haven’t already entered one).
- Back in 2010, in a terrific article by Gramercy, the authors cited research suggesting a wall of debt maturities coming due by 2015.
- We discussed deflationary risk enabled by Quantitative Easing in a prior post.
- Finally, consider the carnage in the riskier sections of the capital markets, i.e., the high yield/junk market and the IPO market. There is something alarming about a roll-up with almost 6x leverage, lots of floating rate debt, and issuing new debt at 10%+ interest rates in this market.
- What about the weakness in US retail, on top of weakness in China?
Something smells funny.
So are we in a sideways market?
Or can you have a correction even as the underlying economy is improving?
At the risk of stating the obvious, investing in the equity and bond markets isn’t risk-free. And it’s unlikely that market participants will accept zero returns (i.e., a sideways market) for taking on that risk. They might as well stay in cash.
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