The market has continued to rally to new highs based on Donald Trumps proposed economic expansion plans, rather than the realization of them. This may change after Trumps inauguration takes place on January 20th as investors realize that a president has only so much power to implement their plans, rather than simply proposing them.
As suspected, the FOMC finally raised interest rates by 250 basis points (.25%) to .75%. Factoring in Trumps increased spending initiatives, the FOMC said it now expects three rate rises next year, as opposed to the two they previously anticipated. Fed funds futures market indicate they believe the year ahead won’t see more than two increases.
The market from a valuation perspective is reminiscent of 2007 and 2014. The PE at 17X forward earnings, the Tobin Q ratio at .97 along with price-to-sales etc. now sit in the top tenth percentile historically. Essentially, valuations are higher now than all time periods other than the roaring 20’s and dot com bubble. Additionally, the price to earnings growth ratio (PEG) is at 1.4, within striking distance or the danger zone of 1.5. In other words, the market continues to bake in all future growth leaving it over valued compared to current economic realities.
The latest survey put out by the National Association of Investment Managers (NAAIM) is currently 101.6% long due to leverage. More telling, there wasn’t a signal bear in the survey. Fear has completely abandoned the market making any negative news a potential catalyst for a quick downside move.
Many asset allocation models are driven by the spread of the earnings yield (inverse of the P/E ratio) to the yield of the 10-year U.S. Treasury note. It’s why many investors argued that stocks were a better buy than bonds, even at elevated valuation while rates were so low. That has finally shifted as the spread is at the lower range with a reading of almost zero. This could cause fund managers to reevaluate positions going into the new year.
Despite currently holding over 30% cash, our sample model portfolio has been able to slightly beat the S&P 500 by almost a half percentage point year to date. While it may not seem like much, this is quite the accomplishment as you would have been able to achieve slightly better returns, with greatly reduced risk.
With the recent Trump fueled rally, the following bears repeating. I equate these times to Warren Buffett’s struggle in 1969 or the late 1990’s when he sat out the market due to what he deemed excessive market valuations. At this time, Warren Buffett’s cash holdings continue to increase which is a tell that he also considers the market overvalued. At the very least, it implies that he cannot find any attractive places (other than cash), to invest his money. Given current valuations, I agree.