Market Musings

By Aline Wealth Management on April 3, 2018

The current economic expansion, which started in the depths of the Great Financial Crisis is now the 3^rd longest, however from a measurement of impact (on the overall economy) the current expansion can only be called sub-par (trending sub-3% for most of the period despite monetary experiments in QE and other machinations-see graph below).  In fact, while we have seen a near 300% increase in the S&P 500 since those scary days in March 2009, this ascent comes on the heels of a 112% increase (to $4.4 Trillion) of the Fed’s balance sheet and a 90% increase (to $20 Trillion) in US Treasury debt outstanding (Factset).  The NYSE market cap now represents 112% of GDP (a top and of much concern to a certain investor in Omaha) – from 55% in 2009.

Of course, the looming question is what may be the unintended consequences of these “monetary experiments”?  What impact have they had on the behaviors of market participants?  What effect has the flood of capital—and cheap (given the low rates) capital—been on financial assets?  Reflections of this type are considered “big picture thinking” –nevertheless, reflections that should be done for it is critical to an investor’s success to attempt to see the proverbial forest through the trees.

One metric that allows investors a bird’s eye view of potential bubbles from unfettered capital flows is a comparison between household financial assets and disposable income in other words:  How much gobbling at the trough have investors done versus their ability to digest?   The second graph below shows US household assets have never counted for more relative to the economy—stocks and equity mutual funds are nearly 130% of the GDP surpassing the prior record of 128% in – wait for it… March 2000.   And it is not just financial assets that look stretched from a valuation lens—using the comparison to income take a look at US home prices (See Graph)—they are close to their highest level ever. (Source: The Economist)

The roots of this over-valuation come in large measure on the heels of the monetary machinations—the globally-coordinated monetary stimulus measures since 2009 and the GFC.   The correlation between the market’s (stock, credit, art, collectibles, real estate—you name it!) advance and the central bank’s largesse is 93% (Bloomberg).  As mentioned by many economists and gurus alike, easy money makes for poor (and risky) capital allocation decisions.  Looking at the number of covenant-lite bonds (those with less protections for investors), as shown in the graph below, which have been gobbled up in this cycle—a cycle where yield hungry (their first question is always ”What’s the yield?” –never asking “What’s the risk”) investors’ appetites are insatiable… until they aren’t.

The other side of the monetary stimulus is the mammoth build-up debt.  The debt load in the US and the budget deficit are approaching dangerously high levels.  When it comes to financial markets, the real serious issue that should make investors quiver with fear is leverage.  While it is hard to know when there is a “tipping point” the concept known as a “Minsky moment” is an element that should not be ignored by investors—especially today (Hyman Minsky, 20^th century economist stated that “stability leads to instability” as good times and higher prices give a false sense of optimism). The charts below speak to this expansion of debt levels. 

US budget deficit as % of GDP

Corporate Bonds – Not in Good Shape

Taking a look at the debt levels globally, one will see that the G20 nonfinancial debt-to-GDP ratio is now at a record 240%, having taken out the peak of the last cycle in 2007 at 212% (each nation has a different component of this debt—in the US it is auto loans, credit cards, student debt and a corporate debt binge that was used to buy back shares). (Source:  FactSet)

James Grant, founder of Grant’s Interest Rate Observer claims that “markets are merely as efficient as the people who operate in them, and fake perceptions caused by artificially-determined interest rates distort investment decisions.   The consequences of manipulated and suppressed interest rates will (someday) lead to a great shake out in finance.”

Bottom-line: investors today should look carefully at their risk in their portfolios—Do they know what they own?  Do they have a sense of the risk in their portfolios?  Have they stressed-tested their financial plan to withstand a substantial downside move in the markets?  This is the type of work investment fiduciaries, like Klein Wealth Management at Hightower, do each day for their clients.