When?!
by Jeffrey Saut, Chief Investment Strategist, Raymond James
June 29, 2015
The market, he had learned, was like the sea, to be respected and feared. You sail on its smooth surface on a placid mid-summer day; you were borne along by a favorable breeze; took a pleasant swim in its waters, and basked in the rays of the sun. Or you lolled in the quite currents and dozed. A cold gust of wind brought you to, sharply – clouds gathered, the sun had gone – there were flashes of lightening and peals of thunder; the ocean was whipped into seething waves; your fragile craft was tossed about by heavy seas that broke over its sides. Half the crew was swept overboard . . . you were washed upon the shore . . . naked and exhausted you sank upon the beach, thankful for life itself . . . . . . “Memoirs of a Trader” from Liar’s Poker by Michael Lewis
Now I wasn’t naked, but Air Canada certainly washed me onto the shores of one of my favorite islands in the world a week ago Sunday, namely Vancouver Island. For those who don’t know, Vancouver Island is huge at approximately 300 miles long, and 50 miles in width at its widest point, making the island the largest on the west coast of North America. My week began that night by having dinner with friends in the city of Victoria. I cannot tell you the feeling one gets when arriving there, not just because of the city’s beauty and cleanliness, but the civility of its people. Indeed, civility is the glue that holds humanity together! Arriving in Victoria is like returning to an era gone by where life was easier and more fun. The next morning I met with about 25 very bright portfolio managers (PMs) and analysts at the BCIMC (British Columbia Investment Management Corporation), one of Canada’s largest institutional investors, which invests on the behalf of public sector clients of British Columbia. From there it was speaking at a lunch for the Raymond James branch and their clients at the posh Oak Bay Hotel followed by another presentation at the branch. A helicopter ferried me from Victoria to Vancouver that afternoon where it was dinner with some PMs.
Tuesday began with four back-to-back one hour meetings at various money management firms. Around noon I met up with Raymond James Ltd.’s (our Canadian subsidiary) venerable equity strategist Ryan Lewenza to do a joint lunch presentation for clients with round two for us that night at the Vancouver Hyatt Regency to about 300 people. Wednesday, it was off to Kelowna, another slice of heaven in Canada’s wine country, for Ryan and I to present at a lunch and then a dinner event at the Harvest Golf Club overlooking Lake Okanagan. After having a probing discussion with my friend, and brilliant portfolio manager, Craig White, it was off to dinner with the gang. Thursday found Ryan and me regrettably leaving Kelowna, but heading to another great Canadian city, Calgary, to see institutional accounts and to do two more presentations.
I chronicled last week’s events not to bore you, but so that I could lump together many of the questions coming from both individual and institutional investors, because for the most part they were very much the same. As I have commented before, I find it interesting that PMs want to know what individual investors are thinking and doing, while individual investors want to know what PMs are thinking and doing. Quite frankly, one of the few differences between the two is that much of the investing public believes the only reason stocks are up is because of the liquidity the Fed has “thrown” into the system. To them I respond, “There is no doubt that has helped, but earnings have grown pretty well since their 2008 nadir.” Then we get slammed with, “How can we be in a secular bull market with political dysfunctionality in D.C., no GDP growth, ISIS, Greece, Iran, North Korea, ad nauseam.” The answer has been repeated by me so many times I almost hate to say it again, but here goes:
The equity markets do not care about the absolutes of good or bad, but only if things are getting better or worse; and, things are getting better.
Of course, the logical next question is, “If that’s true, what about the lack of GDP growth?” Both Ryan and I believe the squishy first and probably second quarters are being driven by one-off events that should mitigate in quarters three and four when the GDP numbers normalize. In fact, you can actually sense this is going to happen given last week’s economic reports. And while it didn’t come from individual investors, the pros proceeded to ask about Warren Buffett’s favorite valuation measurement, nominal market capitalization to GDP. Studying the chart shows valuations are rich by this measure (see chart on next page). However, the reason is because there is virtually no GDP growth. If GDP normalizes in the back half of this year, the attendant chart does not look nearly as expensive.
Then there was always the earnings question, or lack thereof. Hereto, earnings are expected to normalize next year with Standard & Poor’s bottom up operating earnings estimate showing $133.38 for an earnings estimate versus 2015’s estimate of $115.80. If correct, that means the S&P 500 (SPX/2101.49) is trading at a price earnings ratio (PE) of 15.8, which is darn close to its historic median PE of 15.5. Ryan and I would also argue the market’s PE should be somewhere between 18 to 20, but that’s a discussion for another time.
While there were many other questions, the ubiquitous final one was about Greece, which is slated to default tomorrow. For six years I have maintained, “Politicians, bureaucrats and bankers are the same in Europe as they are here. They do not want to lose their jobs and if the EU implodes, they all lose their jobs. Therefore if Greece needs another ‘check,’ Greece is going to get another ‘check’.” So far, that has been a pretty good call. Tomorrow, we’ll find out if it remains a good call. I would counsel Greece, however, to carefully study what happened to Argentina when it defaulted. Recall, after many years of hardship, and after borrowing a lot of money from the IMF, World Bank, U.S., et al., the IMF withheld payments when Argentina failed to meet deficit targets and the default was on. Subsequently, there was a “run” on Argentine banks that was so severe the government had to freeze deposits, which in turn caused riots. The peso was dramatically devalued and all dollar denominated deposits were converted to the devalued peso, wiping out more than half of their value. The economy then fell into depression. Eventually, Argentina’s commodity-centric economy recovered, but only because there was a surge in commodity exports. Greece, by contrast, is less fortunate in that it is heavily dependent on imports. Moreover, if Greece defaults and converts to its old currency (the drachma), private sector business would be crushed since many of their loans are from outside banks and are denominated in euros. Indeed, Greece should study the history of Argentina’s default, but instead Greek Prime Minister (Alexis Tsipras) has called for a “snap referendum” to get European creditors to back down. Hearing that, many Europeans contend, “That has shut the door on any more talks!” Alas, the one thing we learn from history is that we don’t learn anything from history.
The call for this week: Over the weekend there were Greek tweets about long lines at ATMs as the Greek tragedy approaches. This morning Greeks awaken to shuttered banks, capital controls, closed ATMs, and rumors of conspiracies as debt talks collapse leaving our preopening S&P 500 futures down about 23 points at 5:30 a.m. Recall that last Monday’s strategy report stated, “While there are NO signs of a bull market top, my models/indicators suggest the short-term ‘expansion phase’ is over and a contraction phase will begin into the July 4th holiday.” But remember, in the Chinese language the word “crisis” is composed of two characters, one stands for danger and the other opportunity.
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