Wednesday, August 31, 2011
What Are the Markets Telling Us?
If it weren't for various copyright issues, I would be tempted to post in entirety Martin Wolf's column in this morning's Financial Times.
Mr. Wolf does a masterful job of laying out the current economic and market environment. Here's how his piece starts:
What has the market turmoil of August been telling us? The answer, I suggest, is three big things: first, the debt-encumbered economies of the high-income countries remain extremely fragile; second, investors have next to no confidence in the ability of policymakers to resolve the difficulties; and, third, in a time of high anxiety, investors prefer what are seen as the least risky assets, namely, the bonds of the most highly rated governments, regardless of their defects, together with gold.
Our problem, as Mr. Wolf goes on to explain, is that there is virtually no appetite for risk among investors or corporate managers, which can only have negative long term implications for economic growth and job creation.
The risk aversion in the markets has created some uncomfortably anomalies. For example, any asset class that might be considered "safe" offers little or no yield. Buying intermediate maturity corporate or municipal bonds may offer some psychic comfort, but with yields below 1% on most maturities under 5 years the investment appeal is limited.
Rates only have to tick modestly from current levels for "safe" intermediate bonds to record a loss for the year, yet investors are still flocking to the sector.
The stock market offers a more attractive alternative, but this month's extreme volatility illustrates the lack of conviction in the investment community. Ned Davis Research points out this morning that the median 63-day correlation between stock prices in the S&P 500 is at an all-time high - this is a market dominated by traders, not investors.
Put another way, it has been a difficult market for investors who want to base decisions on fundamental analysis. Stock picking has been largely a futile exercise - beta trades are the only way to go, at least in recent weeks.
So what's next?
I still lean towards dividend-paying larger cap stocks, but am mindful that we are up nearly +10% since the lows in early August. The risks of a major policy mistake seem to grow larger every day, not only in the United States but Europe as well.