Two of the most respected names in equity investing are Richard Russell and John Bogle. Richard Russell has been publishing the Dow Theory Letters since 1958 and John Bogle is the founder of the Vanguard family of mutual funds. These equity gurus have more than 100 years of experience between them and share the commonality of fiduciary duty to their clients. This has meant encouraging investment in products other than those they sell at times when they’ve felt that owning the equity markets outright did not present their clients with the best opportunity for asset growth and protection. This is one of those times.
Richard Russell continues to adhere to his bear market thesis based on the lack of confirmation by the Dow Jones Industrial Index (DJI) when the Dow Jones Transportation Index (DJTI) made new highs in May of last year. This year, the roles have been reversed but his operating thesis remains the same. The bear market remains intact because the DJTI failed to confirm the January highs in the DJI. He expects that it could take several years to work through the, “…leveraging and inflation and lying and cheating and shenanigans that lasted from 1945 through 2007.” That’s quite a statement coming from an equity investment advisor.
John Bogle is a bit of a mixed bag. He’s an outspoken republican who voted for Bill Clinton and Barack Obama and has donated nearly half of his net worth to charities. He feels that this may be the worst investment environment that he’s seen in his 60 years in the markets. He strongly supports financial reform and reductions in leverage. He defines a fiduciary standard as, “Put the interests of the client first. No excuses. Period.” Sometimes this means shying away from even low cost equity investments like the ones he pioneered.
Anecdotally, a study was just published that stated that the top 1% is hoarding cash. This study was published by CNBC and has been spun equally to the far right and the left. The left argue that this justifies their case for higher taxes, which would allow the government to then put that cash to work in the economy. The right argues that the Democratic led government must provide some leadership and clarity on tax, healthcare and foreign policy issues before they feel comfortable putting their cash to work. The third option, I suggest is that they simply understand that the primary equity markets are overvalued and have therefore, reduced their outright equity exposure. Furthermore, treasury yields have been artificially devalued to the point that real yields are negative on all maturities less than 10 years. Therefore, cash is the only place to be at this point in time. Perhaps the top 1% actually knows something about investing and growing capital.
The metrics that lead to the valuation concerns include an S&P 500 that is within the top 10% of its earnings range. The point here is that as reported corporate profits have been fantastic. In fact, according to Crestmont Research, the S&P 500 3-year average earnings per share have increased by 80% since the market bottom in March of 2009. As we all know, sustaining a percentage increase becomes increasingly harder with each percentage point that is gained.
Further adding to the rich valuations is where we stand within this business cycle. The recession ended in July of 2009 but post recession real GDP appears to have peaked at 4% in the fourth quarter of last year. We have fallen precipitously since with Q2 real GDP coming in at 1.5%. Wells Fargo Securities published a report using data from the National Bureau of Economic Research that compiled their four primary coincident indicators: employment, real income growth, real wholesale sales and industrial production then indexed them from peak to trough of each business cycle since 1954. They found that there have been a total of six economic recoveries that have lasted more than 36 months. July marked the 36th month for this recovery. Thus, this recovery is becoming longer of tooth with each passing month.
Finally, when we look at the four primary coincident indicators just mentioned, we find that industrial production has been responsible the primary motivation of this recovery. This becomes intuitive if we backtrack the corporate profit scenario we mentioned earlier. Unfortunately, the precursor to industrial manufacturing is the purchasing of raw materials for production. A survey of the primary measures of industrial production and purchasing managers shows that all of the major manufacturing indices have turned negative with most now showing visible outright contraction. Those in contraction include the Richmond Federal Reserve Manufacturing survey as well as the Chicago Purchasing Managers Index and the Institute for Supply Management Report.
The equity markets sit near substantial overhead technical resistance as well as facing a flood of negative fundamental and anecdotal data. Those who’ve managed to ride out the gyrations of the meltdown in 2009 would do well to take some chips of the table at this point if not, outright hedge their equity portfolios. The top 1% has increased their savings rate from 24% of net income in 2007 to 56% currently. Regardless of your political inclinations towards these people, I would suggest we’d do well to emulate their investment models as best we can within the confines of our limited budgets. After all, the government couldn’t have made them that successful by itself.
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