Published On: October 23, 2019
Written by: Ben Atwater and Matt Malick
In the blues music legend of the Crossroads, a musician makes a pact with the Devil to become an extraordinary guitar player in exchange for eternal damnation. It’s a stark proposition.
One can’t help but wonder if the S&P 500 isn’t in a similar situation. After all, despite lots of volatility, the S&P 500 isn’t far off its highs. But it’s had considerable help from what generations of conservative economists have deemed forces of darkness – monetary and fiscal stimulus.
On the monetary side, the Federal Reserve has lowered interest rates twice in 2019 and has also resumed quantitative easing (the creation of additional money supply resulting from the buying of bonds on the open market). On the fiscal side, the Federal Budget Deficit will explode to well over $1 trillion, more than double the level of 2014.
With the legend of the bluesman, his deal with the Devil could engender stardom before he must pay the ultimate price. And such is the analogy to the unpredictability of markets – stimulus makes for an excellent economy until the time comes to face the music.
The other week we wrote you an article called Clear as Mud. Our proposition in that piece was that the U.S. economy is slowing, but stocks are appropriately valued if we continue to see economic expansion, corporate earnings growth, and low interest rates. In addition to unclear fundamentals, there is also a handful of market anomalies that indicate we might be at a crossroads.
According to Ned David Research, over the past 39 weeks the stock and bond markets haven’t been this correlated since the early 1990s. This provides little diversification benefit for a stock and bond mix. In 2019 stocks and bonds have both gained. The reverse phenomenon existed in 2018 with both stocks and bonds registering losses. These results are opposite of what history teaches, which is that stock and bond returns most frequently move inversely.
Despite a general mood of equity market enthusiasm among market commentators, investors seem to be betting on bonds over stocks. Bank of America data shows that investors have piled $339 billion into bond funds this year while pulling $208 billion out of equity funds. This is a contrarian indicator, meaning investors’ pessimism toward equities predicts equity outperformance.
Meanwhile, the S&P 500 can’t consistently get above the 3,000 level. Following its near-term drop from its late July top, not since 1928 has the S&P attempted and failed to retake a 4% sell-off so many times, according to analysts at Sundial Research. This lethargy feels tenuous and uncomfortable.
Another oddity in the current environment is that Bank of America data shows that Treasuries are offering the lowest risk-adjusted returns over the last three years, excluding commodities. This is despite gains in Treasury portfolios. The problem is that yields, although low, have been bouncing all over the place from over 3.2% to under 1.6%.
No matter how you slice it, markets are offering as many contradictory signals as ever. Although we all have some opinion on where things are heading, trying to put your money where your mouth is amounts to nothing more than foolishness.
Process wins the day. We think our investment discipline is built to endure multiple cycles and varied environments. With our commitment to the transparency of individual equity and fixed income investing, we believe that if volatility increases in the decade ahead, we are extremely well-positioned.