Market and Economic Commentary - Week Ending 1/10/2020
Market and Economic Commentary - Week Ending 1/10/2020
Market Recap
January 10th marks the end of the first full week of trading
for 2020. In this week's report I will comment on the performance of Major
World Market Indexes year-to-date as well as significant events in markets and
economies around the world.
In the United States year-to-date, the Morningstar US Total
Market index is up 1.07%, the Dow 30 is up 1%, the S&P 500 is up 1.07%, the
NASDAQ is up 2.30%, and the Morningstar US Small Cap Index is down 0.35.
The CBOE Volatility Index, or VIX, (also known as the fear
gage) is down 8.85%.
In global markets, the Nikkei 225 is up 0.82%, the Hong Kong
Hang Seng Index is up 1.59%, the Shanghai Composite is up 1.47%, the UK FTSE
100 is up 0.60%, and the German Dax is up 1.77%.
In Major Commodities, Gold is up 1.025%, WTI Crude Oil is
down 3.75%, and Brent Crude Oil is down 1.55%.
In the Bond Market, the 10-year US Treasury Interest Rate
declined from 1.919% at the end of 2019 to 1.820% on January 10, for a fairly
significant 5.16 percentage drop in the rate level during the period.
At the same time in the Currency Markets, the DXY US Dollar
Index went from 96.058 at the end of last year to 97.08 on January 10, for a
1.06% increase during the period.
Looking at the Morningstar US Cyclical Sectors, Basic
Materials is down 3.25% year-to-date, Consumer Cyclical is up 1.01%, Financial
Services is up 0.24%, and Real Estate is down 0.30%.
In the Morningstar US Sensitive Sectors, Communication
Services is up 2.032% year-to-date, Energy is down 0.64%, Industrials are up
1.32%, and Technology is up 2.94%.
In the Morningstar US Defensive Sectors, Consumer Defense is
down 0.51% year -to-date, Healthcare is up 0.86% and Utilities are down 0.58%.
Market Price to Fair Value
The current Price to Fair Value for all Morningstar rated
stocks now stands at 1.06. This is the second highest valuation level since
2007, second only to a Price to Fair Value of 1.11 reached in January 2018.
By way of contrast, the 25 Stocks in my BVA Value Momentum
Portfolio Strategy had an average Price to Fair Value of .68 at the end of
2019.
Looking at Price to Fair Value by Sectors, the most
Overvalued Sectors are: Technology 1.15, Utilities 1.14, Real Estate 1.09,
Industrials 1.07, Consumer Defensive 1.06, Financial Services 1.06,
Communication Services 1.04, and Healthcare 1.03.
The most Undervalued Sectors are: Energy 0.86, and Consumer
Cyclical 0.98.
The most Fairly Valued Sector is Materials at 1.0.
Looking at Price to Fair Value by Size of Company, Large Cap
Companies are at 1.06, Medium Cap Companies are at 1.06, and Small Cap
Companies are at 1.01.
Other Significant Events:
The Federal Reserve
Banks’ demand for longer-term liquidity increased in the
latest repo (repurchase agreement) operation. The repo market shook the
financial world in September when an unexpected rate spike choked short-term
lending, spurring the Federal Reserve to intervene.
The repo market is a critical part of the financial system.
It provides a lot of the liquidity necessary to keep the economy moving. It
provides the cash that financial firms need to run their daily operations, by
lending to each other overnight. Financial institutions with excess cash lend
overnight to those that need cash to meet their daily needs. When the repo
market freezes up and cash stops flowing, trouble can echo throughout the
economy. That’s what happened on September 16 and 17, 2019, and in response the
Federal Reserve had to step in and provide tens of billions of dollars to keep
the system functioning.
Usually more than $1 Trillion runs through the repo market
every day. On September 16 and 17, 2019 the market froze up and lenders were
not willing to lend money overnight. The repo interest rate jumped from 2% to
10% in one day. There have been several reasons given for the freeze up, none
of which has been universally agreed on.
Regardless of the reason for the freeze up, the problem
appears to be systemic. So much so that the Federal Reserve, in order to
provide liquidity to the banking system, embarked on its 4th round of
“Quantitative Easing” (i.e. QE, or just plain money printing), since the 2008
financial crisis. In October the Fed announced it would provide $60 Billion of
cash per month, through at least next June, to keep liquidity flowing.
Let’s hope that this cash infusion by the Fed solves
whatever the real underlying problem is. If the Fed indicates it will
continue its QE4 operation beyond the original June 2020 date, it may indicate
the real underlying problem is bigger than anyone thought. If that becomes the
case, it might turn out that one more financial institutions need cash as a
result of making foolish investment decisions. It has happened before and is
one of the risks of providing easy money.
Let’s hope for the best, but this is something I am keeping
a close eye on.
At the start of the 2008 financial crisis, the Fed’s balance
sheet amounted to about $800 Billion. In order to provide liquidity and help
exit the subsequent “great recession”, the Fed’s QE1, QE2, and QE3 (i.e. money
printing) programs caused the Fed’s balance sheet to swell to about $4.5
Trillion. The Fed’s desire is to reduce that amount over time and return to a
more normal level of assets. Before embarking on the most recent QE4, the Fed
had managed to reduce its balance sheet down to about $3.8 Trillion. With the
most recently announced printing program, however, it looks like the balance
sheet is headed back up to the old high.
So, where has all this money gone, and has it helped the
economy?
From 1950 to 1999 the US economy, or GDP, grew at an annual (inflation
adjusted) rate of 3.6%. From 2000 to 2018, the economy grew at an annual rate
of 2.1%. While a 1.5% difference might not seem like much, when compounded over
long periods of time, the result is a significantly lower level of economic
activity. Had the economy from 2000 to 2018 grown at the historical prior
average rate, the economy, standards of living and average worker incomes would
be about 20% higher that they are today. In addition, the velocity of
money as reported by Federal Reserve is at all time lows. This means that the
multiplier effect of every new dollar introduced into the economy currently has
a relatively nominal effect on economic growth.
So, if the Fed’s QE or money printing programs are not
giving the economy an extra boost, where is the money going? Most analysts
would agree the answer is that the money is flowing into the financial markets.
This can be seen through the all-time record highs in global stock markets, and
the low level of interest rates, aided by the Fed’s bond buying
programs. Many very smart Financial Experts feel uneasy about this whole
situation. There is no lack of diverse opinions as to how it will ultimately
play out. The truth is no one knows for sure.
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Len Martinez is a Financial Consultant. Information in the "Bull Valley Advisor" newsletter should not be considered as investment advice or an offer to buy or sell securities. Data is derived from sources considered to be reliable including
Morningstar, StockCharts.com, YAHOO Finance, FINVIZ, TipRanks, Investing.com,
ECRI, OECD, GuruFocus, Crestmont Research, Trading Economics and S2O. Results
are not guaranteed. Len Martinez is not an RIA. The data is shown for
informational purposes and should not be considered investment advice or an
offer to buy or sell securities.
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