Risk/Reward Vol. 371
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
On Wednesday, all three major indices dropped. The S&P 500 lost more than 0.5% for the first time in 50 trading days, the longest such streak since 1965. Reading the financial press the next morning, one would have thought a bear market was afoot. That is until the trading day began. Bang. Bear talk disappeared as the bulls ran again. By the close Thursday, both the Dow Jones Industrial Average and the S&P 500 were up 0.8% and the NADAQ jumped 1.3%. Apparently, every reporter is looking to break the news that a correction is impending, even if one is no where in sight. Lost in the reports was the fact that Wednesday's slip notwithstanding, the S&P has fallen by 1% in a single day only four times this year, its fewest since 1964 and that it has not had 3% intraday drop in over 250 days--an all time record.
Why do stocks continue to rise, Fridays' negative close notwithstanding? As I have preached ad nauseam herein, one reason is that with interest rates so low, there simply is no alternative to stocks right now (TINA). Another reason is that the economy seems to be improving. A third reason is that there are fewer stock issues to buy. Allow me to explain. A limited supply means a higher price---Econ 101. In 1996 there were 7522 publicly traded companies in the US, the stock of which was yours to buy. Today, there are only 3671 public companies. How come? Thanks to central bank policies (quantitative easing, low rates, etc.) the financial world is awash in money. With so much money available, fast growing companies need not look to the public markets for capital. They can access private equity and other such entities which are hungry to put their capital to work. In 1996, 845 companies went public. In 2016, only 127 did. Concomitantly, undervalued public companies can access that same ready source of capital to go private. Read Jason Thomas' piece in Friday's Wall Street Journal on the implications of this development. One takeaway is that the reduction in the number of stock issues available to purchase has contributed to stock prices being less correlated to an individual company's fundamentals and more correlated to fund flows into the market in general.
For the few of us who remain fixated on interest rates and are less fascinated by stock prices (our numbers seem to be dwindling), comments by Robert Kaplan on Tuesday, a noted Federal Reserve dove, caused a minor panic in the fixed income community. He stated that he now is considering voting to raise short term interest rates in December and three times in 2018. I took the opportunity to buy one of my favorites (HPS) on the cheap. It recovered nicely the next day as Mrs. Bond came to see that the rise in short term rates resulting from Kaplan's comments had not adversely impacted longer term rates (read the rate on the10Year US Treasury Bond) and thus should not impact the securities correlated thereto such as HPS. Indeed, the spread between the interest rate on the 2Year versus the 10Year US Treasury Bond has contracted to less than 65 basis points, the flattest since November, 2007. This indicates that Mrs. Bond is pricing in the raises discussed by Kaplan yet still believes the prospects for inflation remain subdued. The persistence of lower longer term rates means that the era of easy money likely will continue even if the Fed increases rates on the short end of the curve. Indeed, with rates so low, corporations and governments are borrowing like mad. Corporate bond issuances are on a record pace and junk bond issuances are 17% higher than in 2016. The issuance of bonds by emerging market countries is through the roof. I read this to mean that the continuation of easy money is less threatened by rate risk than by default risk. (Venezuela anyone? Venezuela? Or 2006? 2006?). But that discussion is for another day.
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