by Craig McFadzean and Christopher Crowe, Turn8 Partners
2013 is almost in the books and it has been a unique year. The stock markets of developed countries have performed well while all other asset classes such as real estate (REITs), commodities, emerging markets, and even bonds have lost money or provided no return. Unfortunately for Canadians the TSX has been one of the worst performing countries and it still remains 13.77% below it’s all-time high, which was achieved way back in the summer of 2008. Meanwhile the US market continues to surprise everyone, fight disbelievers, and march to new record highs seemingly every week. The latest run in the US has led to several people saying the US market is overvalued and is in a bubble.
WHAT TO MAKE OF THE SITUATION?
We are not in the camp of doom and gloom just yet. The majority of the doomsday writers are trying to compare today’s data to the past, which is like comparing apples to oranges given we are recovering from a unique, once in a lifetime event; the Credit Crisis. Truth is, many of those who are ultra-negative are simply saying they “feel” there may be a crash because “things don’t make sense”. There are some companies with valuations that don’t make sense. E.g., Tesla, Amazon, Facebook, Twitter, etcetera, but the majority of the Blue Chip firms have fantastic balance sheets, record amounts of cash, great dividend growth, are buying back shares, and are priced at fair valuations.
Negative – we too are acutely aware of the following concerns…
- The Price-to-Earnings ratio for the market is elevated
- Complacency is alarmingly high as measured by the low VIX
- The glaring issue with country debt levels that are perilously high and rising
- The bumbling governments…worldwide
- The struggles of emerging markets and commodities over the past year
Positive – why we are only cautious and don’t buy in to the current bearishness…
- US GDP is forecasted to increase to 3% next year from just above 2%
- Although the P/E ratios are less attractive they are not in bubble territory
- Government Finance departments around the world remain committed to stimulus
- Asset classes other than equities still carry elevated risk and/or low growth potential
- Companies are still cash rich
- We are starting to see a pick up in mergers & acquisitions
Base Case – Our base case right now is for the market to slow it’s torrid pace and take a breather in what is called a consolidation pattern. This will likely include choppy, range bound trading over the coming weeks allowing prices to normalize to more comfortable levels before starting another positive leg up through the first part of 2014. Overall we believe 2014 should be another decent year.
We’ve started seeing this pause in the markets develop over the last couple of weeks. There have been several negative trading days on low volume and a few scattered positive days driven by the release of upbeat economic data. As with the market slide in June, the irony is once again that some of the recent negative sentiment and pressure actually stems from the positive data, which has caused some short-term traders to fear the government pulling some of their stimulus off the table. We continue to believe this is rather shortsighted and over the longer term the improving economy will continue to push the markets higher.
We feel the only true bubble we are likely in at the moment is a “fear bubble”.
HOW ARE WE POSITIONING?
Each of our portfolios has a short-term model, medium-term model, and long-term model applied to them.
Short-Term View: We are negative on the market given the recent run up and therefore the current risk-return profile is not as attractive. As mentioned above, we believe this is temporary and look to overweight equity again in the New Year.
Medium-Term View: We remain positive, but cautious. If the current stall in the market proves to be more substantial then we will pull a little more off the table, which would likely include our overweights to Japan and US Financial sector. In the New Year we look to overweight cyclical sectors and countries such as energy, industrials, and emerging markets given we believe we will see increased global growth in 2014.
Long-Term View: Very constructive on stocks versus bonds given the strong chance for interest rates to rise over the next 5 to 10 years and rising interest rates mean falling bond prices. Although not exclusive, we favor consistent dividend growing companies in the 2.5% to 5.0% range. These companies tend to have better credit quality and management track records than companies paying higher dividends.
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Originally Published on December 18, 2013 at Turn8Partners.com
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