Investors’ Burning Questions
Last weekend GIM’s Chief Investment Officer, Monty Guild, gave a speech to investors about world markets.
During the Q&A, it became obvious that investors had four central concerns:
1. “The U.S. market is high; how do we know when it is topping or has topped?”
2. “What are the implications of Europe’s problems with Greece?”
3. “China just tightened margin requirements for special trusts that had allowed people to step outside of margin rules — what does that mean for China investment?”
4. “Low interest rates globally are forcing former bond investors to own stocks. How do they know when to get out?”
Let me answer these questions for our readers.
1. How to identify a potential U.S. market top
For decades, we have used several ways to tell if the market is nearing a peak. These are two that we favor.
a. Interest rate increases. If you get three interest rate increases in short-term rates (the Fed funds rate and associated bank rates) it is usually a good time to take some profits. I first came upon this idea in the 1960s when it was promulgated by the venerable stock market analyst Edson Gould. Mr. Gould has long since left us, but his ideas remain important.
b. An analysis of moving averages. Although this technique will not allow one to get out before the market has topped, it is quite commonly known that if you see the 50-day moving average of the S & P 500 cross below the 200-day moving average of the same index, you should sell and stay out of the market until trends substantially reverse. We use this technique, and we also use an analysis of short- and long-term moving averages which allows us to identify markets tops. Gould’s technique can get you out closer to a market top than the moving average crossover model, but both can work.
2. Greece
“Greece is a problem for the European Central Bank, the Euro community, and the unity of Europe. How can you buy Europe with Greece and potentially Russia causing problems?”
Greece may leave the Eurozone, but probably not this year. A Greek exit would cause a market setback. After the exit Europe would be much stronger economically, but weaker politically. The big fear is not a Greek exit, but that such an exit would incentivize Portugal, Spain, or Italy to leave. We do not believe that this is likely in the near term, but it could happen in a few years. Should Greece leave the Euro, the European and U.S. markets would fall — the U.S. market will not be immune to a major problem in Europe.
For now, the dominant influence on European stock markets will be the European Central Bank’s QE program — which is proceeding, and will continue until at least late 2016. QE in the U.S. incentivized stock purchases and moved the stock markets higher — we anticipate a similar effect in Europe. Thus, we anticipate that European stocks will rise this year… possibly substantially. So we are keeping a part of client portfolios in top quality European companies, exporters which will benefit from a lower Euro and which pay dividends.
We suggest that investors use weakness to buy European stocks. Problems caused by Russia’s aggression against its neighbors are a danger for Europe and NATO, and will also impact the U.S. market — but unless the adventurism is huge, the impact will be temporary.
3. China
China tightened margin rules due to manipulation of the rules by some brokerage houses, and simultaneously loosened reserve requirements for banks due to slow GDP growth in the first calendar quarter of 2015.
China is trying to transition from an industrial economy to one which is about 60 percent consumer like other major countries. China is about 40 to 45 percent consumer today, so it has a distance to travel before the government will stop stimulating consumer demand.
A second reason to own Chinese stocks is that the Chinese government is incentivizing stock purchases, so that Chinese government banks and industrial companies will be able to sell shares to the public and improve their balance sheets. Chinese consumers are moving to the fore as Chinese officials continue to incentivize the purchase of stocks and disincentivize overbuilding and over-speculation in real estate.
The message has been heard by investors. Many are losing money on the real estate they may have bought in the last few years, but are now making money in the stock market. The current rally will continue until Chinese companies begin to sell more stock. When this wave of stock offerings begins, we will exit the Chinese market; which we expect will fall under the weight of extra stock sales.
4. Low interest rates
Low interest rates globally are forcing investors out of bonds and into stocks. About 10 major nations currently have negative interest rates, and rates in much of the rest of the world, including the U.S., are too low.
It is clear that bonds are overpriced at the current juncture. Even though inflation is not a problem, bond yields are too low. In our opinion, bonds do not compensate lenders with enough income to make up for the risks of ownership (higher interest rates, failure of the borrower, default, etc.).
Stocks will continue to attract former bond investors until there is another bond market, banking, real estate, or financial crisis, which we anticipate will occur perhaps in 2017 or 2018.
Investment implications: Four points to answer investors’ burning questions. (1) With the U.S. market high, what clues do investors have to identify a top? A top often occurs after the third increase in the Fed funds rate; also a cross of the S&P’s 50-day moving average over its 200-day moving average can indicate a decline that’s likely to continue. (2) A near-term Greek exit from the Euro remains unlikely, so European weakness caused by Greek fears is a buying opportunity. (3) Chinese efforts to rein in excessive margin-debt growth will likely not drag down a rally powered by the flow of money out of real estate and into stocks. (4) Excessively low bond yields, and risks from rising rates, will keep global investors moving out of bonds and into stocks.
