"Kee" Points with Jim Kee, Ph.D.

  • Stocks
  • The Economy


One of the things that we talked about in our first quarter webcast this year (released April 23, 2019) was the strong first quarter bounce in stocks, which was the strongest quarter for equities in about a decade. We asked the question, “given such a strong first quarter, what are the chances that the market will end even higher by year’s end, based upon similar first quarters going back to 1928?” We found that 75% of the time markets experienced continued gains by year-end, and if you were willing to omit the Great Depression-era decline of 1930 (and I was) the odds increase to 7 out of 8 episodes. That’s what we have seen this year as well, with stocks up an additional 4% since that first quarter webcast. Looking at current valuation levels, stocks look a little expensive based upon price-to-forward earnings (i.e. forecasted earnings based upon analysts’ estimates). Not bubble-territory expensive, just at the higher end of normal valuation ranges. Many analysts prefer to look at price-to-cash flow, which eliminates some of the distortions in earnings data that occur because of non-cash accounting rules or charges (like depreciation and amortization expenses). Looked at this way (i.e. on price-to-cash flow), stock valuation levels are a little below average, or on the cheaper side of normal. Some of this reflects the fact that companies continue to generate a lot more cash than they are reinvesting. Part of this is a continuation of a decade-long trend, perhaps due to the push for “asset light” business models enabled by information technology. And, part of it is due to a precautionary motive of firms to hold more cash (rather than reinvesting) due to policy uncertainty in areas like trade policy. Another valuation metric often favored over earnings-based ratios is the market’s dividend yield. It is not perfect because many firms don’t pay dividends, but dividends are real cash outlays that are less subject to manipulation than corporate earnings. On this measure, the all-time low (i.e. stocks being expensive) occurred at the 2000 market peak when the dividend yield for the S&P 500 measured 1.11%. The all-time high (i.e. stocks being cheap) occurred in 1932 after the crash that began in 1929. The market’s dividend yield at that time was 13.84%. Right now it is currently about 1.9%; low, but somewhat expected given the extraordinary low yields on bonds (interest rates) that are viewed as a competing source of yield for investors.


I also mentioned at the beginning of the year that I felt that if trade uncertainty continues, though markets could learn to shrug off the rhetoric, it eventually would weigh on business confidence and that will slow business investment, which will result in slower growth, lower profits, and that ultimately stocks will reflect that with lower valuations. I think that is where we are right now, a critical juncture. Indeed, in this weekend’s Barrons, Goldman Sachs strategist Abby Joseph Cohen argued that the tariff war is causing significant disruptions in China and Europe, with lower capital spending by US companies due to this uncertainty. If this all sounds rather pessimistic, I would also point out that many top strategists feel that Trump’s interest in being re-elected tilts the likely outcome towards conciliation on the trade front. Another positive is the Fed, which has signaled its intention to cut rates. Markets are giving that a 100% probability at the conclusion of the next Federal Open Market Committee meeting on July 31 (according to the Chicago Mercantile Exchange’s FedWatch). So hang in there!