Tag Archives: euro

The Defining Issue for Financial Markets

For anyone who has spent time on the open sea, especially in a small craft, you know the sea can be quite the moody mistress. Some days, the gale winds are howling. Some days the sea is as smooth as glass. The financial markets are quite similar.

In late August, the U.S. equity market experienced its first 10% price correction in four years. That ended the third longest period in the history of the market without a 10% correction, so in one sense it was long overdue. But, because the U.S. stock market has been as smooth as glass for years now, it feels as if typhoon winds are blowing.

Cycles define the markets’ very existence. Unfortunately, cycles also define human decision making within the context of financial markets.

Let’s focus on one theme we believe will be enduring and come to characterize financial market outcomes over the next six to 12 months. That theme is currency.

In past missives, we have discussed the importance of global currency movements to real world economic and financial market outcomes. The issue of currency lies at the heart of the recent uptick in financial market “swell” activity. Specifically, the recent correction in U.S. equities began as China supposedly “devalued” its currency, the renminbi, relative to the U.S. dollar.

Before we can look at why relative global currency movements are so important, we need to take a step back. It’s simply a fact that individual country economies display different character. They do not grow, or contract, at the same rates. Some have advantages of low-cost labor. Some have the advantage of cheap access to raw materials. Etc. No two are exactly alike.

Historically, when individual countries felt the need to stimulate (not enough growth) or cool down (too much inflation) their economies, they could raise or lower country-specific interest rates. In essence, they could change the cost of money. Interest rates have been the traditional pressure relief valves between various global economies. Hence, decades-long investor obsession with words and actions of central banks such as the U.S. Fed.

Yet we have maintained for some time now that we exist in an economic and financial market cycle unlike any we have seen before. Why? Because there has never been a period in the lifetime of any investor alive today where interest rates in major, developed economies have been set near academic zero for more than half a decade at least. (In Japan, this has been true for multiple decades.) The near-zero rates means that the historical relief valve has broken. It has been replaced by the only relief valve left to individual countries — relative currency movements.

This brings us back to the apparent cause of the present financial market squall — the supposed Chinese currency devaluation that began several weeks ago. Let’s look at the facts and what is to come.

For some time now, China has wanted its renminbi to be recognized as a currency of global importance — a reserve currency much like the dollar, euro and yen. For that to happen in the eyes of the International Monetary Fund (IMF), China would need to de-link its currency from the U.S. dollar and allow it to float freely (level to be determined by the market, not by a government or central bank). The IMF was to make a decision on renminbi inclusion in the recognized basket of important global currencies in September. In mid-August, the IMF announced this decision would be put off for one more year as China had more “work to do with its currency.” Implied message? China would need to allow its currency to float freely. One week later, China took the step that media reports continue to sensationalize, characterizing China’s action as intentionally devaluing its currency.

In linking the renminbi to the dollar for many years now, China has “controlled” its value via outright manipulation, in a very tight band against the dollar. The devaluation Wall Street has recently focused on is nothing more than China allowing the band in which the renminbi trades against the dollar to widen. With any asset whose value has been fixed, or manipulated, for so long, once the fix is broken, price volatility is a virtual guarantee. This is exactly what has occurred.

China loosened the band by about 4% over the last month, which we believe is the very beginning of China allowing its currency to float freely. This will occur in steps. This is the beginning, not the end, of this process. There is more to come, and we believe this will be a very important investment theme over the next six to 12 months.

What most of the media has failed to mention is that, before the loosening, the renminbi was up 10% against most global currencies this year. Now, it’s still up more than 5%, while over the last 12 months the euro has fallen 30% against the U.S. dollar. Not 4%, 30%, and remarkably enough the lights still go on in Europe. Over the last 2 1/2 years, the yen has fallen 35% against the U.S. dollar. Although it may seem hard to believe, the sun still comes up every morning in Japan. What we are looking at in China is economic and financial market evolution. Evolution that will bring change and, we assure you, not the end of the world.

Financial market squalls very often occur when the markets are attempting to “price in” meaningful change, which is where we find ourselves right now.

What heightens current period investor angst is the weight and magnitude of the Chinese economy, second largest on planet Earth behind the U.S. With a devalued currency, China can theoretically buy less of foreign goods. All else being equal, a cheaper currency means less global buying power. This is important in that, at least over the last few decades, China has been the largest purchaser and user of global commodities and industrial materials. Many a commodity price has collapsed over the last year. Although few may realize this, Europe’s largest trading partner is not the U.S., it’s China. European investors are none too happy about recent relative currency movements.

Relative global currency movements are not without consequence, but they do not spell death and destruction.

A final component in the current market volatility is uncertainty about whether the U.S. Fed will raise interest rates for the first time in more than half a decade. Seriously, would a .25% short-term interest rate vaporize the U.S. economy? Of course not, but if the Fed is the only central bank on Earth possibly raising rates again that creates a unique currency situation. Academically, when a country raises its interest rates in isolation, it makes its currency stronger and more attractive globally. A stronger dollar and weaker Chinese renminbi academically means China can buy less U.S.-made goods. Just ask Caterpillar and John Deere how that has been working out for them lately. Similarly, with a recent drop in Apple’s stock price, are investors jumping to the conclusion that Apple’s sales in China will fall off of the proverbial cliff? No more new iPhone sales in China? Really?

The issue of relative global currency movements is real and meaningful. The change has been occurring for some time now, especially with respect to the euro and the yen. Now it’s the Chinese currency that is the provocateur of global investor angst. Make no mistake about it, China is at the beginning of its loosening of the currency band, not the end. This means relative currency movements will continue to be very important to investment outcomes.

We expect a stronger dollar. That’s virtually intuitive. But a stronger dollar is a double-edged sword — not a major positive for the near-term global economic competitiveness of the U.S., but a huge positive for attracting global capital (drawn to strong currencies). We have seen exactly this in real estate and, to a point, in “blue chip” U.S. equities priced in dollars, for years now.

In addition to a higher dollar, we fully expect a lower Chinese renminbi against the dollar. If we had to guess, at least another 10% drop in the renminbi over next 12 months. Again, the price volatility we are seeing right now is the markets attempting to price in this currency development, much as it priced in the falling euro and yen during years gone by. Therefore, sector and asset class selectivity becomes paramount, as does continuing macro risk control.

Much like a sailor away far too long at sea, the shoreline beckons. We simply need to remember that there is a “price” for being free, and for now that “price” is increased volatility. Without question, relative global currency movements will continue to exert meaningful influence over investment outcomes.

These are the global financial market seas in which we find ourselves.

Has U.S. Economy Slowed to a Standstill?

Increasingly, we live in a world of now. Instantaneous access to digital real-time data and news has simply become a given. You may be surprised to know that the Federal Reserve has taken notice.

To this point, GDP data from the U.S. Bureau of Economic Analysis (BEA) has arrived after the fact. From the perspective of a financial market and investors that are always looking ahead, GDP data is “yesterday’s news.” Moreover, revisions to GDP can come to us months or even years later, essentially becoming an afterthought for decision making.

Recently, though, the Atlanta Federal Reserve has developed what it terms a GDPNow model. It essentially mimics the methodology used by the BEA to estimate inflation-adjusted, or real, growth in the U.S. economy. The GDPNow forecast is constructed by aggregating statistical model forecasts of the 13 components that compose the BEA’s GDP calculation.

Private forecasters of GDP, such as the Blue Chip Consensus, use similar approaches. Their forecasts are usually updated monthly or quarterly, but many are not publicly available, and many do not specifically forecast the components of GDP. The Atlanta Fed GDPNow model circumvents these shortcomings, forming a relatively precise estimate of what the BEA will announce for the previous quarter’s GDP. The model is still young, but it is beginning to be discovered more widely among the analytical community.

The reason we highlight this new tool is that we’ve incorporated it into our continuing, top-down review of the U.S. economy. More important to our “here and now” thinking is the current reading of this new model. As you can see in the next chart, the forecast by the Atlanta Fed for Q1 2015 U.S. real GDP growth is 0.1%, up from 0% at the end of March. As is also clear from the chart, as of the end of the March, Blue Chip economists were collectively predicting 1.7% growth — quite a difference.

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Chart Source: Atlanta Federal Reserve

Why the drop in the Atlanta Fed real-time forecast for Q1 2015 real GDP? As we look at the underlying numbers in the model, we see recent weakness in personal consumption. Many had predicted an increase in consumption with lower gasoline prices, but that has not played out, at least not yet. Weakness in residential and non-residential construction has also played a part in the downward revision. Weather on the East Coast has not been kind to builders as of late, but that’s a seasonal issue easily overcome by sunshine. Importantly, slowing in U.S. exports and equipment orders meaningfully influenced the March drop in the Atlanta Fed model.

We know global currencies have been weak; the highlight over the last six months has been the euro. With a lower euro, European exports have actually picked up as of late, and the message is clear: The strong dollar is beginning to hurt U.S. exports. We do not see this changing soon. (As you know, the importance of relative global currency movements has been a highlight of our discussions over the past half year.) Finally, durable goods orders (orders for business equipment) have been soft as of late because of slowing in the domestic energy industry. Again, that is a trend that is not about to change in the quarters ahead given dampened global energy prices.

Like any model, the Atlanta Fed GDPNow model is an estimate. Whether Q1 U.S. real GDP comes in near zero growth remains to be seen, but the message is clear, there is downward pressure on U.S. economic growth. This pressure is set against a backdrop of already documented slowing in the non-U.S. global economy. Perhaps most germane to what lies ahead for investors in 2015 is what the U.S. Fed will do in terms of raising interest rates — or not, if indeed the slowing that the Atlanta Fed model predicts materializes.

We believe this slowing will become a real dilemma for the Fed this year and a potential issue for investors. The Fed has been backed into quite the proverbial corner. Whether the U.S. economy is slowing, the Fed is going to need to start raising interest rates for one very important reason.

It just so happens that the end of the second quarter of 2015 will mark an anniversary of sorts. It will be six years since the current economic expansion in the U.S. began. As of July, ours will be tied for the fourth-longest U.S. economic expansion on record (since the Fed began keeping official track in 1945). There have been 11 economic expansions over this period, so this is no minor feat.

The second quarter of this year will also mark the 6 1/2-year point for the U.S. economy operating under the Federal Reserve’s zero interest rate policy. You’ll remember that, during the darker days of late 2008 and early 2009, the Fed introduced 0% interest rates as an emergency monetary measure. That was deemed acceptable as crisis policy. Given that the FED has maintained that policy, it is essentially saying that the current economic cycle has not only been one of the lengthiest on record, but simultaneously is the longest U.S. economic crisis on record.

As we look ahead, the “crisis” in the eyes of the Fed will come to an end as it contemplates higher short-term interest rates.

Although it still remains to be seen what the Fed will decide and when, there is one very important consideration that must be entering their interest-rate-policy decision making at this point in the economic cycle — a consideration they will never speak of publicly. Let’s start with a look at the history of the federal funds rate (the shortest maturity interest rate the Fed directly controls). Alongside the historical rhythm of the funds rate are official U.S. recession periods in the shaded blue bars.

 

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Chart Source: St. Louis Federal Reserve

There is one striking and completely consistent behavior: The Fed has lowered the federal funds rate in every recession since at least 1954. There are no exceptions. You can see the punchline coming, can’t you? Just how does one lower interest rates from zero to stimulate a potential slowdown in the economy?

Of course, in the European banking system and in the European bond market (government and corporate paper), we are witnessing negative yields. Capital is essentially so concerned over principal safety, it is willing to pay to be invested in a perceived safe balance sheet. Will we witness the same phenomenon in the U.S.? A move to negative interest rates in the U.S. would further punish pension funds, which are not only starved for return but are still underfunded despite fantastic returns for financial assets over the past five years — and Baby Boomers have been rapidly moving into their retirement/pension collection years.

Without venturing into negative-interest-rate territory, the Fed is essentially out of interest rate bullets in its monetary policy arsenal. It’s out of the very ammunition it has employed in each and every recession of the prior six decades. If the U.S. were to enter a recession, the Fed would be unable to act on the interest-rate front, as it has for generations.

Is the U.S. teetering on recession? Not as far as we can see, despite the Atlanta Fed GDPNow model’s reading of very close to 0% growth. We need to remember that U.S. GDP growth has been below average in the current cycle and that the cycle is not young. But the time to contemplate questions such as we are posing is well before a recessionary event. If the Fed is going to raise interest rates, it should be while the economy is still growing. Although the Fed will never speak of this publicly, it cannot be trapped at the zero bound (0% interest rates) when the next U.S. recession ultimately arrives.

The proverbial clock of history is ticking just a bit louder as we enter the second quarter of 2015. Is this, perhaps, the key reason the Fed will need to at least begin raising interest rates this year regardless of the near-term tone to the economy?

Investor Concerns: Greece Is the Word

Unless you have been living on a desert island, you are aware that Greece is in the midst of trying to resolve its financial difficulties with European authorities. This is just the latest round in a financial drama that has been playing out for a number of years now. Up to this point, the solution by both euro authorities and Greek leaders has been to delay any type of financial resolution. And that is the exact prescription handed down just a few weeks ago as Greece approached a February month-end debt payment of a magnitude it could not meet. Greece has been given another four months to come up with some type of restructuring plan. At this point, we’ve simply stopped counting how many times euro authorities have kicked the Greek can down the road.

Why all the drama regarding Greece? Greece represents only about 2% of Eurozone GDP. Who cares whether Greece is part of the euro? The Greek economy simply isn’t a big enough piece of the entire euro economy to really matter, is it?

The fact is that the key problems in the Greek drama have very little to do with the Greek economy specifically. The issues illuminate the specific flaw in the euro as a currency and the fact that the euro authorities are very much hoping to protect the European banking system. The reason we need to pay attention is that the ultimate resolution of these issues will have an impact on our investment decision making.

A key characteristic of the euro, which was formed in 1998, is that there is no one overall guarantor of euro area government debt. Think about the U.S. If the U.S. borrows money to fund building bridges in five states, the U.S. government (via the taxpayer) is the guarantor of the debt; it is not the individual debt of the five states involved. Yes, individual U.S. states can take on state-specific debt, but states cannot print money, as can large governments, so there are limiting factors. In Japan, the Japanese government guarantees yen-based government debt. In the U.S., the federal government guarantees U.S. dollar-based government debt. In Europe, there is no one singular “European government debt” guarantor of essentially euro currency government debt. The individual countries are their own guarantors.

The Eurozone has the only common currency on planet Earth without a singular guarantor of government debt. All the euro area governments essentially guarantee their own debt, yet have a common currency and interest rate structure. No other currency arrangement like this exists in today’s global economy. Many have called this the key flaw in the design of the euro. Many believe the euro as a currency cannot survive this arrangement. For now, the jury is out on the question of euro viability, but that question is playing out in country-specific dramas, such as Greece is now facing.

One last key point in the euro currency evolution. As the euro was formed, the European Central Bank essentially began setting interest rate policy for all European countries. The bank’s decisions, much like those of the Fed in the U.S., affected interest rates across the Eurozone economies. Profligate borrowers such as Greece enjoyed low interest rates right alongside fiscally prudent countries like Germany. There is no interest rate differentiation for profligate or prudent individual government borrowers in Europe. Moreover, the borrowing and spending of profligate countries such as Greece, Italy, Spain, Portugal, Ireland and, yes, even France, for years benefited the export economies of countries such as Germany — the more these countries borrowed, the better the Germany economy performed.

This set of circumstances almost seemed virtuous over the first decade of the euro’s existence. It is now that the chickens have come home to roost, Greece being just the opening act of a balance sheet drama that is far from over. Even if we assume the Greek debt problem can be fixed, without a single guarantor of euro government debt going forward the flaw in the currency remains. Conceptually, there is only one country in Europe strong enough to back euro area debt, and that’s Germany. Germany’s continuing answer to potentially being a guarantor of the debt of Greece and other Euro area Governments? Nein. We do not expect that answer to change any time soon.

You’ll remember that over the last half year, at least, we have been highlighting the importance of relative currency movements in investment outcomes in our commentaries. The problematic dynamics of the euro has not been lost on our thinking or actions, nor will it be looking ahead.

The current debt problems in Greece also reflect another major issue inside the Eurozone financial sector. Major European banks are meaningful holders of country-specific government debt. Euro area banks have been accounting for the investments at cost basis on their books, as opposed to marking these assets to market value. In early February, Lazard suggested that Greece needs a 50% reduction in its debt load to be financially viable. Germany and the European Central Bank (ECB) want 100% repayment. You can clearly see the tension and just who is being protected. If Greece were to negotiate a 50% reduction in debt, any investor (including banks) holding the debt would have to write off 50% of the value of the investment. At the outset of this commentary, we asked, why is Greece so important when it is only 2% of Eurozone GDP? Is it really Greece the European authorities want to protect, or is it the European banking system?

Greece is a Petri dish. If Greece receives debt forgiveness, the risk to the Eurozone is that Italy, Spain, Portugal, etc. could be right behind it in requesting equal treatment. The Eurozone banking system could afford to take the equity hit in a Greek government debt write-down. But it could not collectively handle Greece, Italy, Spain and other debt write-downs without financial ramifications.

The problem is meaningful. There exist nine countries on planet Earth where debt relative to GDP exceeds 300%. Seven of these are European (the other two are Japan and Singapore):

Debt as % of GDP

IRELAND                                           390 %

PORTUGAL                                       358

BELGIUM                                          327

NETHERLANDS                                325

GREECE                                             317

SPAIN                                                 313

DENMARK                                        302

SWEDEN                                           290

FRANCE                                             280

ITALY                                                 267

As we look at the broad macro landscape and the reality of the issues truly facing the Eurozone in its entirety, what does another four months of forestalling Greek debt payments solve? Absolutely nothing.

How is the Greek drama/tragedy important to our investment strategy and implementation? As we have been discussing for some time now, relative global currency movements are key in influencing investment outcomes. Investment assets priced in ascending currencies will be beneficiaries of global capital seeking both return and principal safety. The reverse is also true. While the Greek debt crisis has resurfaced over the last six months, so, too, has the euro lost 15% of its value relative to the dollar. Dollar-denominated assets were strong performers last year as a result.

The second important issue to investment outcomes, as we have also discussed many a time, is the importance of capital flows, whether they be global or domestic. What has happened in Europe since the Greek debt crisis has resurfaced is instructive. The following combo chart shows us the leading 350 European stock index in the top clip of the chart and the German-only stock market in the bottom.

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Broadly, euro area equities have not yet attained the highs seen in 2014. But German stocks are close to 15% ahead of their 2014 highs. Why? Germany is seen as the most fiscally prudent and financially strong of the euro members. What we are seeing is capital gravitating toward the perception of safety that is Germany, relative to the euro area as a whole. This is the type of capital flow analysis that is so important in the current environment.

The headline media portray the Greek problem as just another country living beyond its means and unable to repay the debts it has accumulated. But the real issues involved are so much more meaningful. They cut to the core of euro viability as a currency and stability in the broad euro banking system. The Greek problem’s resurfacing in the last six months has necessarily pressured the euro as a currency and triggered an internal move of equity capital from the broad euro equity markets to individual countries perceived as strong, such as Germany. This is exactly the theme we have been discussing for months. Global capital is seeking refuge from currency debasement and principal safety in the financial markets of countries with strong balance sheets. For now, the weight and movement of global capital remains an important element of our analytical framework.

Watching outcomes ahead for Greece within the context of the greater Eurozone will be important. Greece truly is a Petri dish for what may be to come for greater Europe. Outcomes will affect the euro as a currency, the reality of the Greek economy, the perceived integrity of the European banking system and both domestic and global euro-driven capital flows. For now, Greece is the word.

Buckle Up: Monetary Events Are Speeding

Just when you thought the world could not spin much faster, global monetary events in 2015 have picked up speed. Buckle up.

A key macro theme of ours for some time now has been the increasing importance of relative global currency movements in financial market outcomes. And what have we experienced in this very short year-to-date period so far? After years of jawboning, the European Central Bank has finally announced a $60 billion monthly quantitative easing exercise to begin in March. Switzerland “de- linked” its currency from the euro. China has lowered the official renminbi/U.S. dollar trading band (devalued the currency). China lowered its banking system required reserve ratio. The Turkish and Ukrainian currencies saw double-digit declines. And interest-rate cuts have been announced in Canada, Singapore, Denmark (four times in three weeks), India, Australia and Russia (after raising rates meaningfully in December to defend the ruble). All of the above occurred within five weeks.

What do all of these actions have in common? They are meant to influence relative global currency values. The common denominator under all of these actions was a desire to lower the relative value of each country’s or area’s currency against global competitors. As a result, foreign currency volatility has risen more than noticeably in 2015, necessarily begetting heightened volatility in global equity and fixed income markets.

If we step back and think about how individual central banks and country-specific economies responded to changes in the real global economy historically, it was through the interest-rate mechanism. Individual central banks could raise and lower short-term interest rates to stimulate or cool specific economies as they experienced the positive or negative influence of global economic change. Country-specific interest-rate differentials acted as pressure relief valves. Global short-term interest-rate differentials acted as a supposed relative equalization mechanism. But in today’s world of largely 0% interest rates, the interest-rate “pressure relief valve” is gone. The new pressure relief valve has become relative currency movements. This is just one reality of the historically unprecedented global grand central banking monetary experiments of the last six years. At this point, the experiment is neither good nor bad; it is simply the environment in which we find ourselves. And so we deal with this reality in investment decision making.

There has been one other event of note in early 2015 that directly relates to the potential for further heightened currency volatility. That event is the recent Greek elections. We all know that Greece has been in trouble for some time. Quite simply, the country has borrowed more money than it is able to pay back under current debt-repayment schedules. The New York consulting/ banking firm Lazard recently put out a report suggesting Greek debt requires a 50% “haircut” (default) for Greece to remain fiscally viable. The European Central Bank (ECB), largely prompted by Germany, is demanding 100% payback. Herein lies the key tension that must be resolved in some manner by the end of February, when a meaningful Greek debt payment is due.

Of course, the problem with a needed “haircut” in Greek debt is that major Euro banks holding Greek debt have not yet marked this debt to “market value” on their balance sheets. In one sense, saving Greece is as much about saving the Euro banks as anything. If there is a “haircut” agreement, a number of Euro banks will feel the immediate pain of asset write-offs. Moreover, if Greece receives favorable debt restructuring/haircut treatment, then what about Italy? What about Spain, etc? This is the dilemma of the European Central Bank, and ultimately the euro itself as a currency. This forced choice is exactly what the ECB has been trying to avoid for years. Politicians in the new Greek government have so far been committing a key sin in the eyes of the ECB – they have been telling the truth about fiscal/financial realities.

So, to the point: What does this set of uncharted waters mean for investment decision making? It means we need to be very open and flexible. We need to be prepared for possible financial market outcomes that in no way fit within the confines of a historical or academic playbook experience.

Having said this, a unique occurrence took place in Euro debt markets in early February: Nestle ́ shorter-term corporate debt actually traded with a negative yield. Think about this. Investors were willing to lose a little bit of money (-20 basis points, or -.2%) for the “safety” of essentially being able to park their capital in Nestle’s balance sheet. This is a very loud statement. Academically, we all know that corporate debt is “riskier” than government debt (which is considered “risk-free”). But the markets are telling us that may not be the case at the current time, when looking at Nestle ́ bonds as a proxy for top-quality corporate balance sheets. Could it be that the balance sheets of global sovereigns (governments) are actually riskier? If so, is global capital finally starting to recognize and price in this fact? After all, negative Nestle ́ corporate yields were seen right alongside Greece’s raising its hand, suggesting Euro area bank and government balance sheets may not be the pristine repositories for capital many have come to blindly accept. This Nestle ́ bond trade may be one of the most important market signals in years.

As we have stated in our writings many a time, one of the most important disciplines in the investment management process is to remain flexible and open in thinking. Dogmatic adherence to preconceived notions can be very dangerous, especially in the current cycle. As such, we cannot look at global capital flows and investment asset class price reactions in isolation. This may indeed be one of the greatest investment challenges of the moment, but one whose understanding is crucial to successful navigation ahead. In isolation, who would be crazy enough to buy short-term Nestle ́ debt where the result is a guaranteed loss of capital in a bond held to maturity? No one. But within the context of deteriorating global government balance sheets, all of a sudden it is not so crazy an occurrence. It makes complete sense within the context of global capital seeking out investment venues of safety beyond what may have been considered “risk-free” government balance sheets, all within the context of a negative yield environment. Certainly for the buyer of Nestle ́ debt with a negative yield, motivation is not the return on capital, but the return of capital.

This leads us to equities and, again, this very important concept of being flexible in thinking and behavior. Historically, valuation metrics have been very important in stock investing. Not just levels of earnings and cash-flow growth, but the multiple of earnings and cash-flow growth that investors have been willing to pay to own individual stocks. This has been expressed in valuation metrics such as price-to-earnings, price relative to book value, cash flow, etc. To the point, in the current market environment, common stock valuation metrics are stretched relative to historical context.

In the past, we have looked at indicators like total stock market capitalization relative to GDP. The market capitalization of a stock is nothing more than its shares outstanding multiplied by its current price. The indicator essentially shows us the value of stock market assets relative to the real economy. Warren Buffett has called this his favorite stock market indicator.

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The message is clear. By this valuation metric, only the year 2000 saw a higher valuation than the current. For a while now, a number of market pundits have suggested the U.S. stock market is at risk of a crash based on these numbers.

Wells Capital Management recently developed data for the median historical price-to-earnings multiple of the NYSE (using the data for only those New York Stock Exchange companies with positive earnings). What this data tells us is that the current NYSE median PE multiple is the highest ever seen. Not exactly wildly heartwarming for anyone with a sense of stock market valuation history.

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It is data like this that has prompted a number of market commentators to issue warnings: The big bad stock market wolf isn’t coming; he’s here!

In thinking about these numbers and these dire warnings from a number on Wall Street, we again need to step back and put the current cycle into context. We need to put individual asset class movements into context.

In isolation, current stock market valuations should be very concerning (and they are). In isolation, these types of valuation metrics do not make a lot of sense set against historical precedent. But the negative yield on Nestle corporate debt make littles to no common sense, either…unless it is looked at as an alternative to deteriorating government balance sheets and government debt markets.

Trust us, the LAST thing we are trying to do is be stock market cheerleaders. We’ll leave that to the carnival barkers at CNBC, with its historically low viewer ratings. What we are trying to do is “see” where the current set of global financial market, economic and currency circumstances will lead global capital as we move throughout 2015.

Heightened global currency volatility means an increasing amount of global capital at the margin is seeking principal safety. The recent Greek election results are now forcing into the mainstream commentary the issue of Euro bank and government fiscal integrity, let alone solvency. We believe the negative yield on the Nestle ́ corporate bond is an important marker that global capital is now looking at the private (corporate) sector as a potential repository for safety. The Nestle ́ bond is an investment that has nothing to do with yield and everything to do with capital preservation. Nestle ́ has one of the more pristine corporate balance sheets on Earth. We need to remember that equities represent a claim on not only future cash flows of a corporation but also on its real assets and balance sheet wherewithal.

We need to be open to the possibility that, despite very high-valuation metrics, a weak global economy and accelerating global currency movements that are sure to play a bit of havoc with reported corporate earnings, the equity asset class may increasingly be seen as a global capital repository for safety in a world where global government balance sheets have become ever more precarious over the last half decade. The investor who survives long-term is the one with a plan of action for all potential market outcomes. Avoid the tendency to cry wolf, but, of course, also keep in mind that even the boy who cried wolf was ultimately correct.

It’s all in the rhythm and pacing of each unique financial and economic cycle. Having a disciplined risk management process is the key to being able to remain flexible in investment thinking and action.