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Credit Data Flash Yellow Alert on GDP

In the economic cycle of 2003-2007, one question we asked again and again was, “Is the U.S. running on a business cycle or a credit cycle?” How much of the growth was sustainable, and how much depended on an expansion of credit?

That question was prompted by a series on credit data we have tracked for decades, data that tells a very important story about the character of the U.S. economy. That credit data series is the relationship of total U.S. credit market debt relative to U.S. GDP.

Let’s try to put this in English, because the credit data is sending a warning signal about the U.S. economy.

What is total U.S. credit market debt? It is an approximation for total debt in the U.S. economy at any point in time. It’s the sum total of U.S. government debt, corporate debt, household debt, state and local municipal debt, financial sector and non-corporate business debt outstanding. It very much captures the dollar amount of leverage in the economy. GDP is a very straightforward number: the sum total of the goods and services we produce as a nation. So what we are looking at is how much financial leverage in the economy relative to the growth of the actual economy itself has changed over time. What is clearly most important is long-term trend.

From the official inception of this series in the early 1950s until the early 1980s, growth in this representation of systemic leverage in the U.S. grew at a moderate pace. Liftoff occurred in the early 1980s as the Baby Boom generation came of age. We believe two important demographic issues help explain this change.

First, there is an old saying on Wall Street: People do not repeat the mistakes of their parents, they repeat the mistakes of their grandparents. From the early 1950s through the early 1980s, the generation that lived through the Great Depression was largely alive and well and able to tell their stories. A generation was taught during the Depression that excessive personal debt can ruin household financial outcomes, so debt relative to GDP in the U.S. flatlined from 1964 through 1980. As our GDP grew, our leverage grew in commensurate fashion. Dare we say we lived within our means? To a point, there is truth to this comment.

Alternatively, from the early 1980s onward, we witnessed an intergenerational change in attitudes toward leverage. Grandparents who lived through the Depression were
no longer around to recite personal stories. The Baby Boom generation moved to the suburbs, bought larger houses, sent the kids to private schools, financed college educations with home equity lines of credit and carried personal credit balances that would have been considered nightmarish to their grandparents. The multi-decade accelerant to this trend of ever-increasing systemic leverage relative to GDP? Continuously lower interest rates for 35 years to a level no one ever believed imaginable, grandparents or otherwise. That is where we find ourselves today.

Why have we led you on this narrative? Increasing leverage has been a key underpinning to total U.S. economic growth for decades. Debt has grown much faster than GDP since 1980. For 3 1/2 decades now, in very large part, expanding system-wide credit has driven the economy.

Although U.S. total debt relative to GDP has fallen since the peak of 2008, in absolute dollar terms, U.S. total credit market debt has actually increased from $50 trillion to $60 trillion over this time. Moreover, U.S. federal debt has grown from $8 trillion to close to $18.5 trillion since Jan. 1, 2009, very much offsetting the deflationary pressures of private sector debt defaults. To suggest that credit expansion has been a key support to the real U.S. economy is an understatement.

By no means are these comments on leverage in the U.S. economy new news, so why bring the issue up now?

We believe it is very important to remember just how meaningful credit flows are to the U.S. economy now because a key indicator of U.S. credit conditions we monitor on a continuing basis has been deteriorating for the last six months. That indicator is the current level of the National Association of Credit Managers Index.

As per the National Association of Credit Management (NACM), the Credit Managers Index is a monthly survey of responses from U.S. credit and collections professionals rating factors such as sales, credit availability, new credit applications, accounts placed on collection, etc. The NACM tells us that numeric response levels above 50 represent an economy in expansionary mode, which means readings below 50 connote economic contraction. For now, the index rests in territory connoting economic expansion, but the index is also sitting quite near a six-year low.

In our April monthly discussion, we spoke of the slowing in the U.S. economy in the first quarter of 2015. We highlighted the Atlanta Fed GDPNow model, which turned out to be very correct in its assessment of Q1 U.S. GDP. While the Atlanta Fed was predicting a 0.1% Q1 GDP growth rate number, the Blue Chip Economists were expecting 1.4% growth. When the 0.2% number was reported, it turns out the Atlanta Fed GDPNow model was virtually right on the mark. As of now, the Atlanta Fed GDPNow model is predicting a 0.8% GDP number for Q2 in the U.S. (the Blue Chip Economists are expecting a 3.2% number).

Now is the time to keep a close eye on credit expansion in the U.S. We’ve been here before in the current cycle as the economy has moved in fits and starts in terms of the character of growth. Still, a slowing in the macro U.S. economy along with a slowing in credit expansion intimated by the NACM Credit Managers Index is a yellow light for overall U.S. growth. A drop below current levels in the NACM numbers would heighten our sense of caution regarding the U.S. economy.

Although no two economic cycles are ever identical in character, fingerprint similarities exist. At least for the last two to three decades, the rhythm of credit availability and credit use has been one of those key similarities. Although we know past is never a guaranteed indicator of the future, the NACM Credit Managers Index was an extremely helpful indicator in the last cycle. This index dropped into contractionary territory (below 50) in December 2007. In the clarity of hindsight, that very month marked the onset of the Great Recession of late 2007 through early 2009.

Again, for now we are looking at a yellow light for both credit expansion and the US economy. A further drop through the lows of the last six years in the Credit Managers Index would not be a good sign, but we are not there yet. As always, we believe achieving successful investment outcomes over time is not about having all of the right answers, but rather asking the correct questions and focusing on key indicators. September 2015 will mark the seven-year point of the U.S. Fed sponsoring 0% short-term interest rates in the U.S. If this unprecedented Fed experiment was not at least in part aimed at sparking U.S. credit expansion, then what was it all about?

The 0% interest rate experiment is likely to end soon. The important issue now becomes just what will this mean to U.S. credit expansion ahead? We believe the NACM Credit Managers Index in forward months will reveal the answer.

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.