Why Cash Has Become King Again

chess-pieces

Judging by recent headlines, cash is once again king. The Wall Street Journal recently reported that investor cash levels currently represent 5.8% of portfolios, the highest in 15 years.

Many investors interpret high cash levels as a contrarian indicator, suggesting an excessive level of caution. The logic goes that if cash levels are high, there is more “dry powder” for fund managers to invest. Today, however, there is potentially a different interpretation regarding high cash levels.

With U.S. stocks trading for more than 20x trailing earnings, credit spreads tight and volatility roughly 35% below its long-term average, it is difficult to argue that investors are overly pessimistic (source: Bloomberg). Instead, high cash levels are a rational response to the changing structure of cross-asset correlations.

Typically, bonds provide three attributes in a portfolio: income, volatility control and diversification. Slow nominal gross domestic product (GDP) and central bank policy have already conspired to rob bond investors of income. Yet investors have still been aggressive buyers of bonds this year. Why? A large part of the reason has been that bonds have provided an effective hedge against equity risk. Until recently, that is. It is starting to change.

For most of the post-crisis environment bonds have tended to move inversely with stocks. This pattern is consistent with the historic norms: When economic growth and the central bank policy rate are both low, the correlation between stocks and bonds tends to be negative. While growth, both nominal and real, remains muted, central bank policy is evolving. By either choice or necessity, monetary stimulus may be reaching its limits, the Federal Reserve (Fed) is likely to hike rates in December and continue hiking next year.

No longer a good hedge

Under this scenario stock-bond correlations are likely to be higher than the consistently negative levels that have defined the post-crisis environment (see the chart below). Should that occur, bonds will not be as effective a hedge against equity risk. Furthermore, if rising rates are primarily a function of higher real rates, rather than higher inflation expectations, gold may also be a less effective hedge. This leaves cash as the only major asset class available to hedge equity risk.

stock-bond-correlation-3

So it should come as no surprise we are seeing rising cash levels, specifically among multi-asset funds. Fixed income is less attractive at higher correlations, particularly after accounting for low forward return expectations. Instead, portfolios hold more cash.

In short, investors treating high cash levels as a contrarian buy signal may want to consider a different interpretation.

Russ Koesterich, CFA, is Head of Asset Allocation for BlackRock’s Global Allocation team and is a regular contributor to The Blog.

 

Investing involves risks, including possible loss of principal. Diversification strategies do not guarantee a profit or protect against loss in declining markets.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of October 2016 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results. BlackRock makes no representations or warranties regarding the advisability of investing in any product or service offered by CircleBlack. BlackRock has no obligation or liability in connection with the operation, marketing, trading or sale of any product or service offered by CircleBlack.

©2016 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.

Diagnosing the Health Care Selloff

health-equipment

No sector has been a victim of election antics and volatility like health care, the third-largest sector weight in the S&P 500 Index. The S&P 500 Health Care Index is down a little more than 2% this year and the S&P Biotechnology Select Industry Index has plummeted over 15%, while the S&P 500 has notched a decent 6% gain, according to Bloomberg data.

This should come as no surprise: A key factor in the recent selloff has been investor concerns that new regulations could impact the prices of drugs. These concerns are exacerbated by political rhetoric connected to the presidential election, and we think the likelihood of significant reform remains low. Although both U.S. presidential candidates have very different approaches to health care, each has proposed significant changes to the current system. And as politicians suggest plans to rectify an imperfect system, many health care companies feel the heat, particularly biotechnology companies, which then see weakened stock prices.

However, despite the potential for near-term political headwinds, there are positive fundamental and structural factors that suggest some health care companies are being over-penalized.

In recent years, U.S. equities overall have generally seen their stock prices gain from multiple expansion, rather than significant earnings growth. In other words, investors have been willing to pay more for the same dollar of earnings. But the health care sector is an exception; its earnings have been overlooked. The cheaper the stock prices get, the less the stocks are loved.

health-care-earnings-growth

Reform talk could just be talk

So why have health care and biotech stocks been left out in the cold? The market selloff in biotech began last year when Hilary Clinton commented on drug price gouging and the need for increased regulation. In a single day, the Nasdaq Biotech Index dropped almost 5% (source: Bloomberg).

I think this is a classic example of investor behavior driving stock prices rather than investment fundamentals. For now, this reform talk is all rhetoric. Actual reform measures affecting drug pricing would likely take years to legislate and implement. I won’t speculate on whether Congress would remain under Republican control, or which candidate would become president, but I believe that there is a strong likelihood of continued political divisions and gridlock. This suggests that the power to push through major reforms will be limited.

Markets in autumn have historically seen an uptick in volatility, according to Bloomberg data. Given that we are in the final weeks before the election, we expect volatility to continue in the health care sector. In fact, the issue is top of mind for voters. In a 2016 national survey of registered voters, health care ranked number four on the list of importance behind the economy, terrorism, and foreign policy. With so much focus on the sector, health care companies could continue to pay the price for political rhetoric in the near term.

The need for health care

But it’s important to remember that in addition to valuations and earnings, lifestyle and demographic factors support health care over the long term. First, while we can postpone discretionary purchases like a car or new appliances in dire times, health care is one thing we cannot live without. Meanwhile, an aging baby boomer population means demand for health care services will likely continue to grow. And as advancements in technology ensue, so will the average age in life expectancy, thus furthering the need for health care.

Some options to think about

Stocks in the biotech industry have a history of volatility, and given the election, nothing is certain. Yet, the industry is experiencing a wave of innovation. Within this context, it may make sense for some long-term investors to consider how biotech stocks may fit into their portfolio. Investors with a higher risk tolerance and/or a longer-term investment horizon may want to think about taking advantage of market volatility to find select opportunities in health care and biotech. To gain exposure to health care or biotech companies, investors may want to take a look at the iShares Nasdaq Biotechnology ETF (IBB) or the iShares U.S. Healthcare ETF (IYH).

Heidi Richardson is Head of Investment Strategy for U.S. iShares and a regular contributor to The Blog.

Heather Apperson, an Investment Strategist with iShares, contributed to this blog.

 

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Why Defensive Stocks Are Still Not Cheap

price-tag

After leading the market for much of the year, defensive stocks such as consumer staples and utilities have been sliding since mid-summer. The S&P 500 Utilities Index is down 10% from its July peak, while consumer staples companies are down 6% (source: Bloomberg). Minimum volatility strategies, which often emphasize these “low beta” names, are also underperforming after a strong start to the year.

Given the recent retreat and more reasonable valuations, should investors be giving these sectors another look? Not yet. Here’s why.

No good bargains after all

Utilities, consumer staples and other defensive names are still expensive relative to their history, and in many cases, their fundamentals. Large cap utilities stocks are trading at a premium to their 20-year average relative price-to-earnings (P/E) and price-to-book (P/B) ratios (source: Bloomberg). For example, over the past 20 years the S&P 500 Utilities Index has typically traded at around a 25% discount to the broader market. Today the discount is less than 20%.

Nor do the valuations look any better when adjusted for fundamentals. Comparing U.S. consumer staples stocks to the broader global market based on profitability—one of the factors that investors usually note to justify the premium—these stocks appear to be some of the most richly valued in the world.

A modest rise in rates could bring hurt

I believe we’re in a “low for long” world, with interest rates unlikely to revert to their pre-crisis norms any time soon. That said, it will not take a sharp rise in rates to inflict more pain on the defensive stocks; even a small increase should be enough.

While utilities and staples companies have always been valued for their steady, reliable yield, the dividend on these stocks has become even more important in a low yield world. “Bond market refugees” have been flooding into these sectors as one of the last bastions of a +3% yield. This trend has exacerbated the sensitivity of these stocks to even a small change in interest rates.

Since coming out of the recession, the rate on the 10-year Treasury note has explained roughly 80% of the relative value (the P/B of the sector versus the P/B for the S&P 500) for consumer staples companies. See the chart below. It won’t take a return to 5% on the 10-year yield to push the sector lower. Even a 50-basis-point backup in rates (0.50%)—which would put the 10-year yield back to where it started the year—would likely put downward pressure on valuations.

cons-staples-rel-value

At some point we will likely see value return to this segment of the market, but we’re not there yet. High yield, low beta stocks remain vulnerable based on still elevated valuations and hypersensitivity to even small changes in interest rates. I see better value in other sectors such as technology, which are reasonably priced and better positioned to grow in a slow growth world.

Russ Koesterich, CFA, is Head of Asset Allocation for BlackRock’s Global Allocation team and is a regular contributor to The Blog.

 

Investing involves risks, including possible loss of principal. Diversification strategies do not guarantee a profit or protect against loss in declining markets.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of October 2016 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader.Past performance is no guarantee of future results. BlackRock makes no representations or warranties regarding the advisability of investing in any product or service offered by CircleBlack. BlackRock has no obligation or liability in connection with the operation, marketing, trading or sale of any product or service offered by CircleBlack.

©2016 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.

Duration Is on My Mind

tree-rings

Change is in the air. Last month the Bank of Japan (BoJ) introduced a novel plan to target the 10-year Japanese government bond yield, shifting its focus from bond purchases to a long-term rate peg. Stateside, the Federal Reserve (Fed) again left the federal funds rate unchanged, but the probability of a December rate hike is climbing. Global interest rates are likely to rise—or at least fluctuate—after being kept extraordinarily low in the years since the financial crisis.

Although yields are ultralow—the 10-year U.S. Treasury yield is currently around 1.60%—the duration, or interest rate sensitivity, of bond investments has steadily risen (source: Bloomberg). What that means: Even a small rise in rates will likely have a big impact on some bond segments. With duration in mind, which bond segments should investors consider in a potentially rising interest rate environment?

What is duration?

Some fundamentals first. When interest rates fluctuate, bond prices generally shift. Rising rates typically push bond prices lower, while falling rates push bond prices higher. Duration, expressed in years, measures a bond’s interest rate sensitivity. The higher the duration, the more the bond’s price will change when interest rates move, therefore the higher the interest rate risk.

An example: For a bond with a duration of 10 years, it could appreciate 10% in price if interest rates fall by 1%. Should interest rates rise by 1%, the bond could fall 10%. For a bond with a duration of two years, it could appreciate 2% in price if interest rates fall by 1%. The same bond could fall 2% should interest rates rise by 1%.

SHORT DURATION

When we say “short duration,” we are generally referring to bonds that mature within three years. Short duration bond strategies have historically had lower yields than long duration bond strategies, but when interest rates rise, short duration strategies may experience a smaller price drop.

MEDIUM DURATION

This refers to bond funds with average maturities of 3 to 10 years. Usually, yield is higher with these types of bond strategies than with short duration, while interest rate risk is lower than long duration.

LONG DURATION

This generally points to bond strategies with an average maturity of more than 10 years. This strategy usually offers the highest interest rates, which can be optimal in a falling rate environment. But when rates rise, long duration bond strategies can experience sharp price declines.

What to consider, the long and short of it

Generally, when investors believe interest rates are going to increase, they typically shift to a lower duration strategy to potentially reduce the interest rate risk in their portfolios. This is more likely to occur if they hold higher duration bonds. The price of a high duration bond will likely fall more than the price of a low duration bond when rates rise.

This strategy gets a little more complicated when we look more closely and differentiate between different interest rates. A hike in the fed funds rate increases short-term rates, but does not necessarily impact medium- and long-term rates. Even if the Fed does move as expected in December, the impact on the overall bond market may be muted.

So what to do? Know that interest rate sensitivity is currently high, and that a movement by the Fed could push short-term rates up. But don’t be spooked by what the Fed may do. Think closely about the role that fixed income plays in your portfolio.

If, like many investors, you have a long time horizon and you look to bonds for equity diversification and income, then there isn’t necessarily any action to take. Be informed and know what is going on with your portfolio, but also keep the long-term view front and center. Making significant short-term portfolio shifts could compromise your long-term investment goals. In investing, patience is key.

Matt Tucker, CFA, is the iShares Head of Fixed Income Strategy and a regular contributor to The Blog.

 

Investing involves risk, including possible loss of principal.

Fixed income risks include interest-rate and credit risk. Historically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this post is at the sole discretion of the reader. BlackRock makes no representations or warranties regarding the advisability of investing in any product or service offered by CircleBlack. BlackRock has no obligation or liability in connection with the operation, marketing, trading or sale of any product or service offered by CircleBlack.

©2016 BlackRock, Inc. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries. All other marks are the property of their respective owners.

The New Normal

Glen Eagle Logo

As we enjoy the fall weather and enter into the last quarter of 2016 it is useful to look back at where we have been this year and what insight recent events can provide us regarding the future.

Needless to say this has been anything but a normal year. We have witnessed the rise of the Zika virus, the destruction of Syria, the plummet in the price of oil, the Brexit vote of Great Britain, and the chaos of the American Presidential Election…just to name a few events.  And yet, the U.S. financial markets have continued to rise, with the S&P 500 increasing over 5% since the beginning of the year.  So what is accounting for this lack of response from the U.S. financial markets to this global pandemonium?

As other significant economic countries around the world, such as China, Brazil, Japan, or Germany, struggle to maintain sufficient growth, their Central Banks have attempted to spur economic growth by both printing money and lowering interest rates.   While these foreign central banks had hoped their actions would encourage individuals to borrow and spend, in many cases the result has been to inadvertently encouraged foreign investors to pour money into the American financial markets which are viewed as relatively safer and more stable than their global peers.  Additionally, the US Federal Reserve, under the leadership of Janet Yellen, has continued to signal its intent to raise interest rates modestly in the future.  By raising interest rates, the Federal Reserve is likely to strengthen the value of the dollar which increases the returns for foreign investors holding investments in dollars.    Essentially, rational individuals that would traditionally hold their money in bank accounts or foreign investments (that are currently earning little to no money from the lack of high interest rates) have been transitioning their money into U.S. equities in order to try and realize a higher return.  So where does this leave us?

Understanding that we are now within the second longest bull market in American history, with over seven years of continual growth, we believe that investment selection has become even more important.  In comparison to 2011-2013 when the economy was in an early stage growth cycle and investors were able to buy an index while still seeing substanal gains, this is no longer the case.  In particular, we see a need to focus on a few select areas of the market in the near-term.

  • Strong Dividend-Paying Stocks: We expect the Federal Reserve to raise interest rates one additional time this year and at least one time in 2017.  Forecasting for these few rises, however, interest rates will remain extremely low compared to the historic averages.  This will encourage investors to continue buying stocks that have healthy balance sheets and provide high yields by consistently increasing dividends, an action that is attractive to many who need additional income in retirement.
  • Real Estate Stocks: In September the Standard & Poor made real estate its eleventh sector in the S&P500 index. Previously real estate had been included within financials.  We believe that over time this new categorization will encourage many investors to increase the amount of capital they allocate to real estate as they may have been underweight in the sector when it was hidden within financials.  Additionally, REITs or real estate investment trusts pay high dividends, which will again attract income-oriented investors.  We would, however, be cautious with companies that have exposure to the commercial real estate, which seems to be overvalued.
  • Healthcare & Financial Stocks: We believe these are two sectors that will still be attractive in the future but should not be over weighted right now.  Although healthcare will continue to benefit from an aging population and financials will benefit from the eventual increases in interest rates, we believe that these two sectors are most vulnerable to near-term political upheaval after the elections in November.  In particular. banks and pharmaceutical companies have been the target of multiple campaigns throughout this election process.

Final thought

In these times of immense change when there is uncertainty about the future, both in society and in the financial markets, it is not uncommon for us to hear others cite this as the “new normal”.  The argument centers around the idea that the world we live in today is unlike that of the past and therefore we need to develop new rules and approaches.  At Glen Eagle, however, we believe that in these unique times, staying true to who you are and what you believe in is more important than ever.  And for us at Glen Eagle that means adapting to the market with a long-term perspective rather than reacting to the market with a short-term approach.

Wishing you a safe and prosperous fall.

Susan McGlory Michel & The Glen Eagle Investment Team

 

Disclosure: This commentary is furnished for the use of Glen Eagle Advisors, LLC, Glen Eagle Wealth, LLC and their clients. It does not constitute the provision of investment advice to any person. It is not prepared with respect to the specific objectives, financial situation or particular needs of any specific person. Investors reading this commentary should consult with their Glen Eagle representative regarding the appropriateness of investing in any securities or adapting any investment strategies discussed or recommended in this commentary.

Why Bonds May No Longer Be Able to Save Stocks

buoys

Despite recent wobbles, U.S. large cap stocks are having a decent year, up 6% year-to-date as measured by the S&P 500 (source: Bloomberg as of 9/30/2016). This may pale in comparison to a year like 2013, but performance is more than respectable given the anemic growth and the increasingly lengthy profits recession.

The question now is whether it can continue. But to answer that, we need to look at the bond market as much as the stock market.

U.S. equities continue to be buoyed by low interest rates. Many believe this dynamic can go on, since rates are probably going to remain low, creating a still high “equity risk premium”—the likely return from stocks over bonds. Stocks, which by many measures appear expensive, are still cheap because bonds are worse, this contention holds. Although there is a theoretical appeal to this argument, the relationship between stocks and bonds is not stable and tends to be less linear when rates are this low.

A nuanced stock-bond relationship

Historically, stocks do tend to trade at higher valuations when bond yields are lower. Since 1962 the yield on the U.S. 10-year Treasury note has explained roughly 25% to 30% of the variation in U.S. large cap equity multiples, as measured using the trailing price-to-earnings (P/E) ratio in the chart below. The challenge for investors today is that the relationship is not linear; in other words, the relationship differs depending on the level of rates. Lower rates do indeed lead to higher equity multiples, but only up to a point: When yields get very low, as they are today, the relationship breaks down.

10y-yield-vs-sp500-valuations

In fact, there is some evidence that when yields are at very low levels, investors should be looking for higher real, i.e. after inflation, yields to confirm the equity market advance. Using yields derived from the Treasury Inflation Protected Securities (TIPS) market over the past 20 years, equity multiples have been positively correlated with real long-term interest rates. For example, multiples were much higher during the boom years of the late 1990s, a period that coincided with strong growth, despite the fact that real yields were 3%-4%, roughly 10 times the post-2008 crisis average.

This nuance in the stock-bond relationship illustrates the problem of relying exclusively on yields to justify stock prices. While lower rates are generally good for stocks, there are other considerations, starting with economic growth and the factors that drive it.

Productivity matters

In particular, investors should be concerned about the low productivity the U.S. has been experiencing recently. Soft productivity suggests not only slower growth, but more pressure on companies’ margins should wages continue rising. For this reason, valuations have historically been positively correlated with the rate of productivity. But the persistently negative productivity readings of the last several quarters are consistent with multiples 10%-15% lower than they are today.

None of this necessarily suggests we are heading into a bear market. Valuations have crept even higher in many of the post-1980s bull markets. That said, low U.S. rates are not enough to constantly propel stocks higher.

Investors looking for better opportunities with less stretched valuations should reconsider international markets, particularly Japan, where multiples can still provide a lift for stocks.

Russ Koesterich, CFA, is Head of Asset Allocation for BlackRock’s Global Allocation team and is a regular contributor to The Blog.

 

Investing involves risks, including possible loss of principal. Diversification strategies do not guarantee a profit or protect against loss in declining markets.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of October 2016 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results. BlackRock makes no representations or warranties regarding the advisability of investing in any product or service offered by CircleBlack. BlackRock has no obligation or liability in connection with the operation, marketing, trading or sale of any product or service offered by CircleBlack.

©2016 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.

The Market Has Lost One of Its Pillars of Support

market-pillars

Julian Edelman, star wide receiver for the New England Patriots, was recently asked what advice he’d been given by his father, Frank. “Go back to the fundamentals of life. Life’s hard, but it’s simple,” he replied.

Fundamentals matter in life and in markets. Sometimes we overcomplicate the financial world, focusing on central bank policy, elections, technical trends and fund flows. But the focus should be on the fundamentals: Over long periods of time, buyers want their money where there is abundant — and growing — cash flow. That cash flow, whether measured by net profits, margins or return on equity, is the ultimate driver of stock prices. Investors are willing to accept price volatility in return for access to those cash flows. It’s that simple.

The current US business cycle will go down as one of the greatest free-cash-flow cycles in history. Companies threw off huge amounts of excess cash by making clever use of technology, tapping cheap labor and taking advantage of declining energy prices, the low cost of capital and the resumption of modest global economic growth.

In the wake of the global financial crisis, the market was skeptical for several years, and stock prices grew much more slowly than profits and cash flows.  At the same time, the central banks of the world, dissatisfied with slow economic growth and low inflation, indirectly supported the stock market with extraordinarily accommodative monetary policies. We had a market that was supported by two pillars: high profits and low yields. Both pillars have contributed to the rally from the post-crisis S&P 500 low of 666 to around 2,150 today.

However, lately there has been a turn in the markets, and not for the better. The building blocks of long-term market advances, growth in cash flow and profits, have weakened. Falling commodity prices, slowing world growth and eroding pricing power are contributing to the earnings malaise. Company revenues are no longer exceeding economic growth, and cost-cutting efforts have plateaued. Selling, general and administrative expenses have been rising in most sectors, as have labor costs, while pervasive weakness has spread to most market sectors as year-over-year profit growth has stalled.

For six years, one of history’s great market advances had the fundamental support of an efficient and growing private economy along with the tailwind of low interest rates in the bond market, the principal alternative to stocks. But now we are left with but one pillar of support, built on a shaky foundation of central bank liquidity. In a low-interest-rate world, there is a school of thought that stocks offer the best and only investment alternative. That’s scary to me. I’m comfortable in a world that has two pillars of support, but not in a world where the more important of the two is eroding. What happens when the central banks are no longer supplying us with low yields? Can the markets still advance without either profits or low yields? I doubt it.

Euphoria is not yet driving the market, thankfully, but that may not be far off. Often, late in business cycles, high spirits drive the market to unsustainable highs. The present eight-year-old cycle is already the third longest in history, while the longest cycle in the last century was ten years.

While I hope that the fundamentals return to robust health, until there is convincing evidence of this, slowly stepping away from this fast-paced market may be the safest course.

Where to go? High-grade corporate bonds are not a perfect asset class, but they may be able to offer a portfolio resilience, with historically lower volatility than stocks and enough anticipated return to merit investors’ attention.

James T. Swanson, CFA is the chief investment strategist of MFS Investment Management.

 

The views expressed are those of James Swanson and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation or solicitation or as investment advice from the Advisor.