Sunday, November 20, 2016

U.S. equities at highs but...

Comments about the equity market's resilience continue.  After a one night Trump win related dive on November 8-9, stocks have been, in the aggregate, on a consistent rise.  Looking at SPY, the S&P index fund, it is well above an all time high.  Short interest is at 26%.  Then looking at QQQ, representing the Nasdaq, it has just this week passed its all time high which was set in the early 2000 tech bubble.  Short interest is at 16%.

These "all time high" numbers are somewhat misleading.  They do not take into account inflation and they do not take into account the comparative cost of capital at various periods.  Nevertheless, they are interesting benchmarks.  They do reflect basic proven valuation analysis if one believes in a market that is relatively efficient over time.  So prices measured by return on equity, the cost of capital calculated based on interest rate levels and perceived risk, and the expected longevity of current returns are all factored in, theoretically speaking that is.

The most subjective aspect of this type of analysis is the length of time the equity is determined to be able to maintain its competitive advantage.  Determining this is complicated by the environment in which a firm operates.  Currently the market is projecting that Trump as president will benefit business as regulations are modified, corporate taxes reduced, and penalties for repatriation of profits relaxed.  For the moment, the market is ignoring other concerns.

Those concerns are related to the stability of a Trump presidency and the coherence of his policies. They relate as well to his appointments that are ongoing.  These will affect the valuation of the market no matter how well firms are doing today.  How long will the market do well if Trump doesn't settle down and show a predictable management style?  If the market is discounting a six or seven year continuation of global competitive advantage that may be fair now, but will it be generally viewed that way six months from now.

There are doubts here, and that view leads to the thought that the market is due for a significant correction.  When is unknown, but stable investors will not view unstable leadership as a positive for overall valuation.  The coming weeks and months could see the indexes strong levels at risk.  The shorts are there for a reason, and the market seems too high to have much of a short covering rally. What is the risk/reward here?  It may not be attractive.

We will watch with caution.


Anonymous Anonymous said...

"When is unknown" is the one comment in this post that has already been proved to be a certainty. Today's market did not proceed with caution. Your overall view is shared by many, but bubbles happen. Could we be on the cusp of one?

4:45 PM  

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