Two trends are in the process of fighting for dominance in the market, and they won’t be able to coexist for much longer.
While the market is filling with news of investors fleeing for the hills, all the stops are being pulled out to make sure there is no alternative but 100% exposure.
Warnings over these trends are now even coming from Goldman Sachs. The perennially bullish bank is finally falling in line with CitiBank, JP Morgan, Bank of America, and UBS by warning of a possible big drop in the market.
On the other side, we have central banks with zero and negative interest rate policies, and corporations issuing debt and dumping the proceeds directly into their own shares.
Now we’re facing a daunting challenge to the status quo that has persisted for years on end — economic reality.
Flows and Trends
If you watch inflow and outflow data, or have read the coverage from myself and many others, you’re undoubtedly aware that corporations are solely responsible for the near-all-time-high market valuations.
Remove the $450 billion corporations are expected to use to buy back shares, and a $225 billion shortfall appears as all other types of investors scale back investment and exposure.
That trend is continuing unabated. Bank of America Merrill Lynch just confirmed that outflow over the last week, with outflows over the last five weeks hitting a level not seen in nearly five years.
$7.4 billion was withdrawn from global equity funds last week, bringing the five-week total to $44 billion, the largest since August 2011.
$3.9 billion left European equity funds, and $2.3 billion fled emerging markets, reflecting the dismal prospects for overseas and global growth for the foreseeable future.
Meanwhile, fixed income funds drew in $3.5 billion, money market funds brought in $10.9 billion, and precious metals attracted $1 billion.
In the bond world, $3.2 billion went into investment-grade bonds while $1.5 billion fled junk bonds and $900 million came out of low-yield government bonds.
The writing is on the wall, people want safety. The only attractive aspect of investing via corporations is that they’ll essentially have to pay their bills, and even then the outflow from junk bonds suggest more people are only comfortable with the biggest and best sticking to the deal.
Second Quarter Blues
All of this is sentiment based, but there are hard numbers backing this up. Earnings and sales are weak and the second quarter is looking worse than the already disappointing first.
The only sectors that saw earnings growth year-over-year were consumer discretionary, telecom services, and health care. The same goes for revenue growth, if you add in consumer staples.
On the whole, second quarter is estimated to see an earnings per share drop of 4.6% compared to a 2.8% drop in the first quarter, along with a sales decline of 1.3% compared to a 0.6% drop.
That brings us back to Goldman Sachs. The bank just released a report showing that the “median” stock has never been more overvalued.
So this is bad timing for an earnings and sales squeeze, to understate it.
I hold no place for in my heart for Goldman, and I wouldn’t mind reserving a place for it in the graveyard, but I have no qualms with using its numbers and ignoring the advice that fishes for muppets for it to sell to.
Here is part of the report:
Valuation is a necessary starting point of any drawdown risk analysis. At 16.7x the forward P/E multiple of the S&P 500 index ranks in the 86th percentile relative to the last 40 years. Most other metrics paint a similar picture of extended valuation. The median stock in the index trades at the 99th percentile of historical valuation on most metrics (see Exhibit 3).
Somehow Goldman Sachs still maintains a 2100 target for the S&P 500 through all of this, but with a mere six months and current trends, I’m pretty sure that is the muppet bait.
Tried and True
Though all of this paints a grim picture, the simple fact is that we cannot predict which narrative will become dominant.
Either investors as a whole can weather a flat market with volatility and stick with the “there is no alternative” camp until metrics improve, or they’ll realize that people are quietly opting out and realize they don’t want to be left holding the bag.
The thing is, we don’t really have to pick sides. While the overall market is in make-or-break mode, our investment strategies can succeed regardless of which camp is the victor.
For example, while the S&P 500 has been all over the place this year and is up just 0.13% as of this morning, NOBL, an ETF with some of the strongest dividend paying components of the index, is up 6.79%.
When the full index was down over 10%, it was only down 5%, and the clear and steady divergence over the course of the year shows ongoing investor demand for the safety of dividend stocks.
The demand is well-deserved in this market. Dividend stocks are different beasts than the rest of the market because of how steady payments to shareholders influence cash flows. Buybacks and excessive debt issuance are virtually nonexistent.
Then there is the emergence of the precious metals sector from the last several years of the commodity version of the Hunger Games.
Gold miners are basically where oil companies wish they could be, with an “all-clear” signal flashing for all to see.
While precious metals have seen a broad inflow for months now, there are a handful of companies that are well-adapted with low-cost deposits.
Even without market worries, ZIRP, NIRP, and a strong dollar boosting precious metals, they are going to see both business and demand improve.
So while the battle of forces in the market rages on and passes through trials and tribulations, my focus is on stable dividend paying stocks that offer great shareholder income and the best-of-breed gold miners.
Judging by the trends in the market, I’m far from alone.
