Investment Management

Aging Out???

If the stock market does not wonder about an investor’s age, should an investor wonder about the stock market’s age? We would argue no. But that has not stopped many pundits from opining about the age of the current “bull” run in most any equity market around the world, concluding that there must be a fall in stock prices “just because.” We think that silly, as markets do not typically collapse with economies as strong as they are currently around the globe. Could there be a short-term correction of 5%? Assuredly one could come “out of the mist” with no particular rationale as to why. However, such a correction would probably be bought quickly by all who missed the market before and want to get in – keeping any such “correction” short and shallow.

Specifically, let’s look at a spike in interest rates as a potential catalyst for an equity market setback. In the chart below, one will see that if the 10 year Treasury yields increased 40 – 60 basis points (BPS) in a span of 20 days, US stocks might well fall 5%. As the reader will also note, the stock market can withstand even higher interest rates without a fall, if those rate increases are spread out over a longer period of time.

So, while a “spike” in interest rates is a possible worry, are monetary conditions “easy” or “tight”? In fact, conditions are “easy” and have been getting easier as seen in Chart 2.

Finally, is there still value in the US market as represented by the S&P 500? Following, please find some interesting work done by UBS, the very large Swiss bank.

Looking at the left side of the chart, the reader will note that relatively low interest rates and tax rates add 6 – 7 multiple points to equity P/E ratios. In other words, in a low interest rate and low tax rate environment, stock prices should be higher than they otherwise would be. On the far right of the chart, note that the stock market is still cheap to UBS’ Fitted P/E.

Again, we say that “bull” markets do not die of old age, especially when economies are strong. Certainly, there could be a “correction” – but one we believe would be short lived.