Are Your Munis Stuck in a Pre-2008 World?
July 22, 2019
Walt Czaicki Hello everyone. It’s been an interesting year. And as we anticipate the investment climate to change, we also expect the need for services that both participate and defend is likely to increase. That said, in the second quarter, investors enjoyed strong returns across the board in the capital markets. And if we combine it with what happened in the first quarter, year to date, investors have had a very favorable experience.
Walt Czaicki Yet, a risk that they need to be mindful of, is that corporate profit growth, be it Europe, Japan, emerging markets, and even the U.S., is likely to be lower versus year-ago levels. This is largely a byproduct of the global economy itself slowing. And when we look at the Global Purchasing Managers Index, in fact it has declined over the last 14 months. More recently, it’s broken below the 50 mark, which puts us in a contractionary phase. That and other concerns have made the equity markets quite volatile in recent quarters.
Walt Czaicki If we were simply to isolate the S&P 500 year-to-date, the returns have been quite good. But when you talk to many investors they don’t feel that way. Perhaps that’s because if we just go one quarter back into 2018 and we look at the price level of the S&P on October 1st, compared to where it finished on June 30th, they’ve effectively ended up in the same place. This and other concerns including the direction of monetary policy, fiscal policy, trade issues, as well as global political concerns, have kept investors on edge.
Walt Czaicki Most prominent perhaps is what the Fed might do next. Last year, they were in a tightening phase. Now, they stand ready to cut interest rates if need be to keep the expansion going. And typically, what’s driving the Fed’s thinking is the shape of the yield curve itself. If we look at the difference between the 10- and a two-year Treasury note, which traditionally investors do, we’re approaching that zero line or close to inverting. However, if we go shorter on the yield curve, when we compare what three-month Treasury bills are yielding, compared to 10-year Treasury notes, that has in fact inverted.
Walt Czaicki Now typically an inverted yield curve portends either an economic slowdown or worse, a recession. And while we’re not forecasting the latter, we do anticipate the Fed to be accommodative as the year closes out. So, stay tuned. So, what’s a bond investor to do? We continue to recommend a global credit barbell, which is a mix between rates and credit. The good news is, a portfolio with this composition gives you a yield comparable to just simply an all-U.S. high-yield bond portfolio, with the added bonus of better downside protection in periods of bond market stress.
Walt Czaicki Turning to equities. When we look at the valuation picture, it remains mixed, in that the long-term, the PE ratio is just above its long-term average, whereas when we turn to price-to-sales equities appear a bit more expensive. However, offsetting these valuation concerns, is what investors are actually doing with their money. Year to date, they’ve been fleeing equities, yet chasing the perceived safety of fixed income. Should this trend and money reverse, that means more buying power for stocks and potentially higher stock prices.
Walt Czaicki But yet, the need to do your homework has not abated. In fact, the factors that have been long-term success over time, such as companies with high earnings growth, companies with consistent earnings, as well as high profitability, are desirable characteristics that we think makes sense in the current environment.
Walt Czaicki Digging a little deeper, strong balance sheets matter. And they’re different from where they were in the mid 90s. If we were to go back to 1995, over 90% of U.S. and European corporations had favorable financial characteristics. If we fast forward to today, it’s just north of 50%. And commonly, a strong balance sheet could lend itself to stronger profits and potentially higher stock prices.
Walt Czaicki Another strategy that allows us to participate and defend is an effective long-short strategy. And more importantly, it keeps people committed as a part of their portfolio to their overall plan. And in the final, that’s what matters. You have to be in it to win it. And if we were to look at the stock market going back, say, 37 years, if an investor simply missed the best three months, they would have had a third less capital than they would have otherwise had, had they stayed invested in the market.
Walt Czaicki This is tried and true approach in terms of “not timing the market but time in the market”, which complements our long-term advice quite well. Which is, be global, be balanced and be active. Thanks, and we’ll see you next quarter.