The economic impact of Hurricane Harvey continues to be tallied, but the financial and commodity markets turned to focus on other issues last week. As the Party Congress in China drew to a successful close, industrial commodity prices resumed their advance, gaining 1.5% for the week. In a related China note, the initial Bitcoin offerings were declared illegal, causing an 11.7% decline for Bitcoins and leading investors back to gold (+1.8%) and silver (+2.2%). Labor Day marks the traditional end to the summer driving season and, like clockwork, the price of both heating oil and natural gas gained 5.74% and 3.86%, respectively. Small cap stocks again led the market last week, adding 2.3% versus the 1.4% for large cap stocks. Among the economic sectors, health care issues led the market last week, picking up 2.9%, followed by the information technology sector gaining 1.9%. The market laggards were limited to shares of the interest rate-sensitive finance and utility sectors, driven by Friday’s 0.80% loss for the ten-year Treasury bond.
This week, I am revisiting the concept of diversifying away from this year’s market leadership (Facebook, Amazon, Google, Netflix and Microsoft) and into the less trafficked segments. Not to yell ‘FIRE’ in a crowded theater, but 2017’s market leadership is very narrow, with fully 40% of the gain over the last two years attributable to the increase in valuation afforded the earnings of these companies. Note that it is not their growth in earnings, but the valuation investors are applying to earnings. For investors of a certain age, this should sound painfully, and I do mean painfully, familiar. At the end of the first quarter of 2000, virtually the same situation had developed around shares of Microsoft, Dell, Cisco Systems and Intel. History does not always repeat itself; however, it more often rhymes. Unlike the year 2000, the current economic climate shows little signs of excess as witnessed by inventory levels, wage growth, and inflation. After last November’s election, there was a surge of investor interest in the stock market that has not only faded, but the August data from the Investment Company Institute indicates a net liquidation of $22.6 billion in domestic equity. At that pace, support of those lofty valuations will become increasingly tenuous.
There have been questions following an earlier note regarding the magnitude of the debt for equity swap that has taken place over the last seven years, and whether a cause and effect relationship exists between the debt for equity swap and its support of current equity prices. The answer to that question is yes, and to illustrate the point, I again turned to the team at Crandall, Pierce & Company who supplied the exhibit below. We are fast approaching a decade of decline in available shares, and these are not small reductions; the scale is in billions of dollars with the last three years exceeding $100 billion annually. The rules of supply and demand have not been repealed, and interest rates do not appear to be moving materially higher, so there is little to alter the trajectory of this dynamic. The point is to remain invested, but to be mindful in where you invest.
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