INCOME THEME INTACT
This brings us to one of our favourite strategies — Safety and Income at a Reasonable Price. This is what works in a deflationary environment, and if you don’t believe we are in one, then look no further than the article on page B5 of last Thursday’s WSJ (Law Firms Offer Discounts, Play Matchmaker). I mean, come on, when law firms embark on the path of adjusting their fee structure to the benefit of their clients, you know that you are definitely in a cycle that is beyond the norms of the past five decades.
So, it should come as no surprise that once again, bond funds took in $6.66 billion of fresh inflow last week on top of $5.9 billion the week before that; and that U.S. equity funds again suffered a $9.54 billion net outflow (and this occurred on the back of a $4.6 billion net redemption the prior week). Of course, the recent backup in yields could mean that as strong as the demand has been, it has recently been overtaken by the deluge of supply as both governments and corporations have moved aggressively to tap this seemingly insatiable appetite for income-generating securities — $67 billion of new Treasury offerings last week alongside a flood of new issuance in the corporate bond sector — with a growing number offering debt in much longer duration than we have seen in the past.
All we can say is that the most compelling risk-return attributes lie in the BB sliver of the bond market — the best of the investment-grade space where the yield is juicy at an average 6.7% and provide a very nice 300 basis point premium over A-rated bonds and over 220bps over BBB product. In both cases, about 100bps above the pre-bubble normal spread.
THE TRIED, TESTED AND TRUE MARKET INDICATOR
Indeed, prior to a client meeting last week, one of our senior officers posed the question to me as to what I would look at as a tried, tested and true indicator of when to turn more optimistic on equities.
There actually is a good one — revisions to analyst earnings projections (data out monthly).
The 12-month forward S&P 500 earnings estimates, for example, peaked at $103.61 per share right when the market peaked in October 2007. It bottomed, believe it or not, in March 2009 (right at the market lows), at $60.08.
The consensus analyst earnings estimates on a 12-month forward basis peaked this year in April — again, right when the S&P 500 did — at $94.79. It has since declined for five months in a row and so far in September is down 1.3%, to $86.74.
From the April peak, bottom-up earnings estimates have come down 8.5%. We have data back to the mid-1980s and while earnings downgrades can happen in the context of a bull market, when they are down as much 8.5% in an eight- month span it is always in the context of an overall bear market. Let’s respect what the historical record tells us on this score; that we will have to be patient before calling an interim bottom.
