Our Clients' Top Questions AnsweredAugust 2014
Chief Investment Officer, Ronald Sanchez, and Vice Chairman, Mackin Pulsifer, traveled to various locations around the country in the spring and summer to share Fiduciary Trust's market views with our clients. The following is a summary of frequently asked client questions and our views on these topics.
Q. Is the market too expensive?
Expensive is relative. The judgment is relative to the outlook for inflation and interest rates, the trend of corporate earnings and the ever present, volatile influences of geo-politics as they might impact economies and individual businesses.
Interest rates are at levels not seen since the late 1950s, deliberately repressed by Fed policy. Earnings are rising smartly, and measures of current and future inflation are indeed modest. Add to this mix that bond prices have enjoyed the support of a 30+ year tailwind as inflation unwound from the post Great Society/Vietnam peaks reached in 1979.
So, a narrow view taken without this perspective might accurately say the S&P 500 at 17.5x trailing earnings versus the 50-year average of 16.5x is expensive. Yet, with rates and inflation so low and earnings rising, the forecasted multiple of the S&P 500 is 14.9x next year and 13.4x in 2016; hardly lofty, so long as the favorable trends prevail.
Q. How long can equity prices climb?
No one can honestly answer. Our experience suggests equity prices should trend upward until investors sense that the favorable conditions underpinning business, such as stable and low interest rates and inflation, and accelerating earnings growth, are beginning to slow.
As best we can foresee the future, these market-supportive rates of change may begin to slow next year if the familiar inhibiting influence of a less-supportive Fed policy - perhaps an outright hike in the Fed Funds rate - dashes bullish market sentiment temporarily. However, we believe that equities would be able to endure a gradual rise in rates that is based on an improving economy.
Q. Where should we be invested in regards to fixed income?
In general, there are few opportunities for gain across fixed income sectors. The Fed and its fellow central banks have quashed rates to levels that normally would not prevail in a global economy now clearly well into recovery, although the recovery is advancing at different rates across the world. Hence, to expect a capital gain from bonds is really to make the call that recovery will peter out and deflation prevail. We do not hold this pessimistic view.
So, why today hold fixed income securities at all? One strong reason is to blunt ever-present equity volatility in a portfolio. Another is to provide a steady flow of income, albeit meager today. A third reason is that there are always opportunities for gain among the many sub-sectors of the asset class.
Q. Are you concerned that investors have decided that “it’s different” this time, and risk is being mispriced?
So far, there is little evidence of mispriced risk. The foundation on which markets’ valuation measures are built appears reasonable.
We are still in Kansas and the craziness of the tech bubble is not at all apparent. Intel, for example, traded at 45x its earnings on June 30, 2000, near the tech peak; today, the multiple is a more grounded 17x.
It seems likely that the Fed’s ZIRP (Zero Interest Rate Policy) has pushed many investors to pay high prices for conventionally slow growing businesses as they seek income. Electric utilities are an example. Similarly, high-yield ‘junk' bonds are being priced at such a narrow spread over Treasuries that buyers are ignoring their inherent riskiness.
These are discrete mispricing examples, not strong evidence of wide spread "it’s different" hysteria as was so prevalent in 2000. Through the second quarter of the year, US markets, as well as equities around the world, continued to rise.
This communication is intended solely to provide general information. The information and opinions stated are as of August 15, 2014, and may change without notice. The information and opinions do not represent a complete analysis of every material fact regarding any market, industry, sector or security. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.
Chief Investment Officer
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