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Stocks Mixed as Global Dominoes Wobble

By John Persinos on June 14, 2018

The U.S. economy is expanding, unemployment is low, the Federal Reserve professes moderation on tightening, large-cap growth stocks lead the market, mergers and acquisitions are booming, and Wall Street boasts of tech disruptors that are changing the investment rules. Amid this backdrop, the bull market keeps chugging along.

Yep, investors have been partying — like it’s 1999.

The parallels between the turn of the millennium and today’s conditions are too great to ignore. The prosperity of the late 1990s eventually gave way to the dotcom bust in 2000. Do we face a similar fate?

The major stock indices closed mixed today, as worsening crises lined-up like dominoes ready to topple. Equity markets right now are overvalued relative to historical benchmarks. Catalysts for a correction are abundant in America and overseas.

Last weekend, the farcical G7 summit was a signal that world leaders are losing control of economic forces.

The White House convened Thursday to discuss new tariffs against China. In response, China warned today that previous progress in trade talks would be lost if the U.S. implements new tariffs.

The Trump administration’s America First policy has put the U.S. at odds with not just China but traditional allies. The western alliance is unraveling, with ripple effects throughout the global economy.

Talks to revamp the North American Free Trade Agreement (NAFTA) are bogged down. The rift between the U.S. and Canada is complicating negotiations. If NAFTA falls apart, scores of companies will suffer as the global supply chain is thrown into turmoil.

Britain’s exit from the European Union, aka “Brexit,” is faring poorly. British and EU leaders are scheduled to meet this month to iron out details of their divorce, but the two parties remain far apart.

And then there’s Italy, land of wine, song… and debt.

Dark clouds are forming over this Mediterranean nation, as the country’s mismanaged economy sinks deeper into the kind of dysfunction for which the Italian government is famous. Italy’s new anti-establishment coalition this week proposed expensive social programs that would sink the country even further into debt.

It’s increasingly difficult to make investment decisions in today’s upside-down world.

President Trump has warmly embraced North Korean leader Kim Jong Un but pointedly insulted Canadian Prime Minister Justin Trudeau. Kim is the murderous dictator of a totalitarian state; Trudeau is the democratically elected leader of a longtime American ally.

It reminds me of Bizarro World in the Superman comics that I used to read as a kid. In Bizarro World, reality is turned on its head — “goodbye” means “hello,” and “yes” means “no.”

Wall Street has tuned out the North Korean summit, which produced nothing tangible except perhaps the prospect of more talks. The Singapore summit was a showbiz spectacle, sort of like WrestleMania for pundits. Monetary policy gets less attention on cable TV but it carries considerably more weight.

The European Central Bank today left interest rates unchanged, but the trend in the U.S. and abroad is toward monetary tightening. Yesterday, the Fed hiked interest rates and noted that two more boosts are coming this year.

Higher interest rates from the Federal Reserve and ECB, combined with a strengthening U.S. dollar, are a particular threat to emerging markets.

A stronger dollar and higher rates make dollar-denominated debt more difficult to service in emerging markets, dampening economic activity and putting pressure on local currencies. A vicious cycle starts, as weakening currencies make dollar debt even more onerous. It’s a dynamic that spawned the 1998 financial crisis in Asia.

The virtues of value…

Today’s risks make this an opportune time for you to revisit the virtues of value stocks, which appear to be on the cusp of a revival. Growth stocks have substantially outperformed value stocks year to date, but the former have been bid to euphoric levels.

The chart below tells the story. It depicts the long-term trend of the cyclically adjusted price-to-earnings ratio (CAPE), a valuation metric created by Yale economist Robert Shiller.

CAPE now stands at 32.99, more than twice its median of 16.15.

CAPE’s current level was only exceeded during major crashes, such as the 1929 market frenzy, the 2000 dotcom bubble, and the 2007 equities and subprime housing bubbles.

CAPE constitutes price divided by the average of 10 years of earnings (moving average), adjusted for inflation. CAPE provides a deeper context for valuations because it assesses probable returns from equities over a longer period.

With valuations excessive and headline risk growing, it stands to reason that value stocks and related value funds have recently shown signs of resurgence.

Investors who bid up the prices of splashy tech stocks with lousy fundamentals have fallen for the familiar mistake that “things are different this time.” But the time-tested rules never change. Investors learned that lesson the hard way, when tech stocks crashed in 2000. Emphasizing value will provide protection when the dominoes start to fall.

Thursday Market Wrap

  • DJIA: -0.10% or -25.89 points to close at 25,175.31
  • S&P 500: +0.25% or +6.86 points to close at 2,782.49
  • Nasdaq: +0.85% or +65.34 points to close at 7,761.04

Thursday’s Big Gainers 

Maternity apparel retailer posts strong earnings. 

E-commerce platform unveils new online tools.

Generic drug firm gets FDA nod for new treatment. 

Thursday’s Big Decliners

Apparel retailer’s earnings slump.

Arts and crafts retailer’s sales miss expectations.

Analysts look askance at medical device maker’s debt offering.

Letters to the Editor

“Are utility stocks threatened by higher interest rates?” — Norman H.

As rates rise, utilities must pay higher costs on their loans for the capital expenditures that provide their future lifeblood. Moreover, higher rates make utility stocks less attractive, from a risk basis, when compared to interest-pegged income alternatives. But the strongest utilities will weather the turbulence.

Questions about income investing? Drop me a line: mailbag@investingdaily.com

John Persinos is managing editor of Investing Daily.

 


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