C.J. Lawrence Weekly – Volatility Returns (Chairman, James Moltz)
This week we are pleased to offer thoughts on the market from our Chairman, James Moltz. Jim launched the Weekly Market Comment at the original CJ. Lawrence back in the early 1970s and authored the piece for several decades. We are fortunate to have his perspectives and are grateful for his leadership in our investment process. Please do not hesitate to reach out if you have any questions.
The abrupt rise in stock market volatility is being driven by a growing concern that recently enacted fiscal stimulus will overheat the economy bringing with it inflation, higher interest rates and federal funding issues. The 10% correction in the major U.S. indices is testimony to the market’s penchant to discount the future. Right now, business is good. Reports from Davos confirm that global corporate leaders are very optimistic about the outlook. But recent editorials in The Wall Street Journal, The New York Times and The Economist offered varying degrees of caution. The Economist’s February 10th cover carries a speeding car describing the American economy as “running red hot”. Inside the issue it pleads for the Fed not to lose its head. While official inflation numbers are relatively benign, several companies have recently announced the need for higher prices to offset rising transportation and materials costs. Numerous businesses have offered bonuses or wage increases to be funded by lower corporate taxes. LinkedIn, which focuses on corporate hires, sees a heightened demand for workers. All this has caught the market’s eye.
In the bond market, investors cite the movement in the 10-year treasury yield as telling. Since December it has advanced from 2.4% to 2.9%. The Fed is promising three fed fund increases in 2018 and some believe it will be four. Quarterly targets have been set to retire its fixed income inventory. However, the combination of the tax cut ($1.5 trillion) and increased spending ($ 400 billion) will double the 2019 budget shortfall to $1.19 trillion. That must be financed. A spike in short rates can be costly. At the end of 2017, 50% of U.S. debt matured in three years and the average coupon was only 1.77%. The U.S. is going to be in the awkward position of the Fed selling paper or letting it mature while The Treasury is issuing record new amounts hoping foreigners and U.S. investors will be buyers. A weak dollar would not help the cause.
Using S&P 500 earnings of $153.00, the Index’s p/e has declined from a high of 18.8x to the current 17.1x. The average low p/e for the past three years is 16.1x. A 16.0 multiple produces a 2448 Index Price of 6-7% below the February 9 close of 2619. Essentially that would allow 4% inflation and results in a 6.3% earnings yield. Current estimates for 2019 income are around $155.00 – $170.00. Future price action will depend heavily on upcoming inflation and interest rate news.
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