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How We Arrived Here & What We Must See

CAMS Weekly View from the Corner – Week ending 11/24/2017

November 27, 2017

The 2008/09 Financial Crisis has been coined The Great Recession.  Global policymakers, led by Chairman Bernanke’s Federal Reserve, took historic actions to halt cascading prices throughout markets fearing a deflationary spiral.  There were two stand-out policy actions taken by the Federal Reserve.

Zero Interest Rate Policy actions whereby the Fed lowered interest rates to a previously unthinkable level of near zero percent.  In addition, Quantitative Easing whereby the Federal Reserve expanded their balance sheet (think money printing) from $800 billion to $4.5 trillion in a six short years – truly historic action.  This was an all-out attempt to reflate the economic system – think asset price inflation – to reestablish confidence.

In follow-on years higher prices coupled with continued ZIRP and QE brought on the phrase “reaching for yield” to describe general behavior of reaching further and further out on the investment risk spectrum.  The citizenry grew tired of near zero percent interest rates on traditional safe forms of savings such as Savings Accounts.  The reach for yield process was and still is consistently preceded with the exasperated statement – “Where else am I going to put my money”.

Simultaneous to the reach for yield process was a highly incentivized citizenry to incur more debt in light of ultra-low interest rates.  Combined, this had resulted in increased risk exposure on personal balance sheets via higher levels of debt relative to Disposable Personal Income.

Collectively, we now have low levels of savings and higher debt levels while our general savings is further out on the risk spectrum.  With the on-going tightness in the employment market wages have picked up and if tightness continues wage growth rates should accelerate.

Importantly, in this asset price reflation storyline, wage growth rates have trailed far behind that of asset price growth rates leaving in its wake a societal distortion on wealth.  The middle class has been challenged with this as more have gone either upper-middle or lower-middle according to their exposure or lack thereof to the asset price inflation.

Asset prices have escalated so far so fast in relation to economic activity and wage growth rates that we now see asset prices relative to GDP and average wages at historical extremes.  All told, markets are elevated (stocks, raw land, housing, etc.) to historically high valuation levels that rival or exceed previously notable timeframes such as 2000 and 2008.

High valuation levels do not equal guaranteed problems

Collective market participants can bid prices up to very high valuation levels (such as they are now) because there is a built-in view that underlying fundamentals will be strong and earnings will be explosive to the upside justifying the seemingly “overvalued” market levels.  The problem occurs when the exuberant earnings expectations do not materialize or worse, turn down.

Expensive markets in anticipation of strong earnings that fail to emerge force collective market participants to readjust their expectations via lower prices.  This is what occurred in 2000 and 2008.

Just because markets have gone up notably does not mean they will keep going up and simultaneously just because markets have gone to very high levels of valuation does not mean they have to correct downward significantly.  In light of the above we emphatically offer we need to see strong economic growth with follow-on strong earnings growth rates to support these elevated markets.

If you missed our last webinar, you’ll find the presentation materials below as well as a link to the full presentation replay.

I wish you well…

Ken Reinhart

Director, Market Research & Portfolio Analysis

Portfolio Manager, CAMS Spectrum Portfolio

Footnote:

H&UP’s is a quick summation of a rating system for SPX9 (abbreviation encompassing 9 Sectors of the S&P 500 with 107 sub-groups within those 9 sectors) that quickly references the percentage that is deemed healthy and higher (H&UP).  This comes from the proprietary “V-NN” ranking system that is composed of 4 ratings which are “V-H-N-or NN”.  A “V” or an “H” is a positive or constructive rank for said sector or sub-group within the sectors.

This commentary is presented only to provide perspectives on investment strategies and opportunities. The material contains opinions of the author, which are subject to markets change without notice. Statements concerning financial market trends are based on current market conditions which fluctuate. References to specific securities and issuers are for descriptive purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. There is no guarantee that any investment strategy will work under all market conditions. Each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. PERFORMANCE IS NOT GUARANTEED AND LOSSES CAN OCCUR WITH ANY INVESTMENT STRATEGY.

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