I guess everyone sees what is going on in the global equity world.
The US equity market, by all consensus including everyone at a cocktail party I went to last Saturday night, is the global equity market of choice. Yes, of course everyone is bullish and I’m sure investors are shifting portfolio allocations as I write this.
And yes, this is making me extremely uneasy.
We calculate a six-year total rate of return on our US equity mutual fund, Acker Finley US Value 50, on the front screen of our website, here. And on selected days we are up 250% over a rolling six-year period on recent days the market closes, handsomely outperforming our benchmark, the S&P 500 Total Return Index in Canadian dollars. Can we do any better? I don’t think so.
In other words, the fundamentals of the US economy, especially with falling energy costs and ever increasing US dollar, haven’t been this good for a long time. As my cocktail banter shows people see what’s going on here. Yes, the U.S. equity market has figured out this good news a while ago and has accordingly priced these improving fundamentals with ever increasing share price valuations while the market bears were yelling “Bubble!” And people being people they are lining up for the returns that have already happened!
As usual in these monthly blogs, let’s have a look at our Model Price chart on the S&P 500 Index to see what is going on.
S&P 500 Index with weekly price bars andEBV Lines (colored lines).
As a reminder we aggregate all companies in the S&P 500 Index into one chart on a market capitalized basis (like the S&P 500 Index itself), so we can see where the market – S&P 500 – is trading relative to its EBV lines.
As you can observe the US market, as defined by the S&P 500, is still in the middle of the zone bookmarked by EBV+3 and EBV+4. If the market rallied to EBV+4 (2206) this would represent a gain of some 7%. If the market corrected back to EBV+3 (1764) investors would be suffering losses of almost 14%.
For people new to Model Price Theory [MPT] the index value or price can move within an EBV zone with no real consequence. However when a transit occurs – index value or price crosses one of our parallel lines – an EBV line, either positive or negative this gives Model Price users a signal that fundamentals are improving or deteriorating, respectfully.
Squeezing Up to the Top of EBV+4
The next few quarters are usually very strong, seasonally, for US equity share prices. And I do expect the S&P 500 Index to squeeze up to EBV+4 giving equity participants more equity gains over the next little while. This shouldn’t be hard to imagine as worldwide investors (especially Japanese and European investors) evaluate rates of return on global assets and seeing their portfolio equity returns in US dollars will simply say to their respective financial advisors, “Gimme more of that!”
Risk versus Return
As I have said previously, the S&P 500 Index can float between EBV+3 and EBV+4 without consequence according to Model Price Theory [MPT]. However there is a big difference in the risk/reward scenarios if the Index is closer to EBV+3 than EBV+4. I would caution U.S. equity investors’ that as the S&P 500 Index pushes closer to EBV+4 the more investment risk investors are taking with their US holdings.
Everyone now sees the US equity market as the market of choice, in terms of rates of return, for the next few quarters at least. At the same time as the S&P 500 Index pushes towards EBV+4, investors are taking on an increasing amount of risk with limited upside return, assuming EBV+4 is the maximum valuation level this market will achieve (and this will be a future blog post for sure!).
For investors who have been in the US market since the market bottom of March 6, 2009, it has been one hell of a ride. (From EBV+1 to a little under EBV+4, so far!) Unfortunately new investors hoping to capture any of these huge index gains of the past will be sadly disappointed. I’m not predicting doom and gloom here but just pointing out the obvious…returns will be lower with a much higher risk levels for those first timers eagerly throwing their capital in US equities at this time.