The markets have sold off a bit this week. However, we do not see the current short-term volatility in the market as any type of threat similar to the market collapse of 2008. Corporate balance sheets, earnings projections, consumer debt service ratios, and the amount of overall leverage in the economy are all at the opposite end of the spectrum when compared to 2008. We want to remind clients to keep their focus on the numbers and ignore the noise from media on T.V. While nobody can predict the future we can study the economic and stock data and compare it versus other time periods where market corrections occurred. We are watching the volatility closely but have not found any economic or earnings data that justifies a major correction.
There have been a number of years that the market has had intra-year declines of over 10% and finished the full year up nicely. Here are a few recent examples:
2003 – the market was down 14% during the year and finished up 26%
2010 – the market was down 16% during the year and finished up 13%
2012 – the market was down 10% during the year and finished up 13%
Valuations are getting close to normal levels but they are by no means at “bubble” levels. The media will of course talk about Facebook or other momentum stocks getting too rich in valuations but the Nasdaq itself is still trading at a 16 Price to Earnings ratio (P/E) versus trading at a P/E of over 60 in 1999 – that was indeed a bubble. The only bubble we see, which Warren Buffet recently commented on, is in long term Treasury bonds that are trading at very high prices while producing very low yields. As interest rates go up gradually over time these long term bonds could see big price declines.
While U.S. Corporations have accumulated a record amount of cash they are not taking on a lot of risk by using leverage/borrowing to grow their businesses. This is actually something we need to see change in 2014. With the cost of capital at less than 4% for corporations issuing bonds, etc. they need to take some risk, make acquisitions, and invest for growth. We are seeing some signs this is starting to happen and it could be a key factor in GDP growth for 2014.
We have had several “real world” conversations with corporate executives that indicate they are going to “work around” the dysfunction in Washington and start investing their record amount of cash in acquisitions, technology, equipment and other growth initiatives. They plan on growing “despite, not because of” Washington. One of the most interesting conversations we have had this week was with the managing partner of one of the largest professional staffing companies in the U.S. who indicated that the last two months have been incredibly busy and that he is shocked at the increase in activity. This hopefully will translate into a surprise jump in job growth in the next few months.
Consumers have cleaned up their household finances in comparison to 2007 and are taking advantage of low interest rates which results in more disposable personal income to stimulate the economy. Consumer spending has been very steady and has been a positive surprise for many economists during this economic recovery.
Affordable housing will continue to be a major contributing factor for economic growth for the foreseeable future. Demand has started to come back and we anticipate the Federal Reserve going very slow on any major changes in interest rates which will allow the recovery in housing to continue to help U.S. economic growth and job creation.
The macro economic reports that came in this week also showed some positive news for the economy:
JOBLESS CLAIMS DROP:
The number of Americans filing first-time claims for jobless benefits fell last week to the lowest level since before the recession, pointing to further progress in the labor market. Initial jobless claims decreased by 32,000 to 300,000 in the week ending April 5th-the lowest level since May 2007. The number of people continuing to receive jobless benefits decreased by 62,000 to 2.78 million in the week ending March 29th, the lowest level since January 2008.
EUROPEAN COMPANIES CASH FLOW RECOVERING:
Bloomberg notes that European companies’ cash balances and cash flow from operations are at 11 year highs. However, rather than investing that money back into their businesses, companies are instead choosing to return the cash to shareholders at the highest rate in 12 years, suggesting that European executives remain skeptical about the durability of the Euro Zone’s economic recovery.
The volatility will likely continue to be frustrating for all of us in the short term. However, we will utilize any selloff to continue to rebalance and add to the investments at attractive prices.