What we expected may be what we get

With the first quarter of 2014 behind us, let’s consider where we stand now versus our outlook at the beginning of the year, when we were favoring the US equity market over other equity markets. And our outlook for fixed income was based on a bias toward higher interest rates — not a dramatic hike in rates, but a downward drift in bond prices across the board. So we were favoring credit and shorter maturities.


Are stocks getting stretched?

This month we're observing the fifth anniversary of the US equity bull market, which started after the S&P 500 Index troughed at 676 on 9 March 2009. With events in Ukraine and other geopolitical hotspots to distract us, we may not have celebrated with cake and candles, but we’ve reached an important milestone.

Are we on track for another year of stock gains, or have we reached the market top? Let’s take a look at some equity valuation measures to see where we stand.


Will margins and profits peter out?

Right now we’re seeing signs of stress in the markets. The US economy seems to be softening. Emerging market worries, rough weather and inventory buildups have certainly contributed to the slowdown — not to mention the tense situation between Russia and Ukraine, and the uncertainty about what steps the rest of the world will take in response.


Can that cool app I created make me a billionaire, too?

Just about everyone is entranced with the recent news out of Silicon Valley about billions of corporate dollars being used for acquisitions. Many of the buyouts we’re hearing about are software companies that were startups just a few years ago. There is almost an 1849 Gold Rush mentality now in California. Who can think of the next software application that can be sold to a big Internet company for billions of dollars? Basement and garage software entrepreneurs work feverishly, hoping their ideas can make it big.

But what do company takeovers and buyouts mean for those of us who invest in the market?

Watching one tea leaf: The relative price of credit

The price of riskier corporate bonds such as high-yield and emerging market debt is measured in terms of extra yield. This is the price of credit, which is measured relative to the highest-quality bond issuers, like the US government. Credit-sensitive bonds are backed by companies with uncertain financial strength, and accordingly have lower credit ratings. Because these bonds represent a category of risk higher than other markets, they often signal distress or economic deterioration before other markets decline. These markets can be good "tea leaf" indicators about the path ahead. Also, when these markets show strength (less excess yield), they often signal better times for stocks and other assets.


Hard winter, soft economy

Data falling with the snow

At the end of last year, virtually all economic reports in the United States were accelerating. Nonfarm payrolls were consistently better, manufacturing activity was picking up and consumers were poised to spend again. Since then, we’ve seen softness in home sales and car sales — the two linchpins for my case that the economy has continued to move forward. Factory orders and retail sales have also been disappointing relative to expectations.

Can we say that the steady storm of harsh winter weather has been the culprit? Certainly that could be the case with autos and perhaps housing in the affected regions, but not with factory orders. I doubt that weather is the whole story. There must be something else.


Optimism? Pessimism?

Bullish or bearish?

Market strategists are often put into one of two camps: perma-bears, who deliver a steady message of doom, such as “prepare for the imminent collapse,” or perma-bulls, who always see the rosy side.

In my work, I’ve never run across anyone who fits these simplistic labels. I find that most of my fellow strategists and economists are trying to sort through and evaluate large amounts of conflicting and puzzling data. We face the reality that the world around us is always changing, and our forecasts may need to adapt to what we actually observe.