What Are the Markets Telling Us (1)

What Are the Markets Telling Us?

After the equity market’s post-May declines, stocks have risen throughout June to reach 2950 on the S&P 500, and hit another all-time high on Wednesday, July 3. Then, on July 10, the S&P 500 hit the 3,000 mark for the first time ever before ending the day lower.  

The bond market on the other hand is signaling distress as yields have steadily declined (meaning that prices have risen) throughout the month. The ten-year Treasury yield is currently hovering near 2%; for reference, it started 2019 at 2.7%, and nine months ago was 3.3%.

If you believe that markets are discounting mechanisms that provide us information on the state of the world, then which one of these markets—equity or bondsis providing the correct answer?

If stock prices reflect the inherent value of companies, the current price to earnings (P/E) of the S&P 500 is telling us that fundamentals in corporate America are still strong. The S&P 500’s P/E ratio of 17x is at best fair versus historical multiple ranges, neither terribly over or undervalued. 

But the bond market (and the White House) is telling us that Federal Reserve policy needs to be more accommodative, and that a rate cut is necessary to keep economic activity moving. Recent data suggests slower growth in the U.S. Both manufacturing and consumer spending seem to have slowed. 

The impact of the U.S.’ new tariffs on Chinese goods is difficult to assess, but at a minimum they create uncertainty for businesses around things like input costs and supply chain management (even though the stock market does not seem to care). 

The Federal Reserve this week suggested that interest rate cuts are possible at its July meeting. That in turn suggests a need for stimulus given the economic backdrop. Score one for the bond market, which has essentially already discounted a decline in interest rates. 

Perhaps the stock market has also discounted that an interest rate cut will provide enough stimulus to keep earnings chugging along. If that proves true, we could experience a continuation of growth (through monetary stimulus) that could keep multiples in line with a “Goldilocks scenario” world (neither too hot nor too cold).

Ultimately, however, the clearest answer is that debt continues to grow. The debt cycle has been pushed further out and financing, restructuring and refinancing will continue to be available for companies given the low rate environment.

It may look OK right now for companies to pile on more and more debt, with an economic backdrop that is still relatively stable. However, these situations usually end badly, and an economic downturn or recession could mean trouble for companies that are so highly leveraged. 

Segal Marco Advisors provides consulting advice on asset allocation, investment strategy, manager searches, performance measurement and related issues. The information and opinions herein provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. Segal Marco Advisors’ R2 Blog and the data and analysis herein is intended for general education only and not as investment advice. It is not intended for use as a basis for investment decisions, nor should it be construed as advice designed to meet the needs of any particular investor. Please contact Segal Marco Advisors or another qualified investment professional for advice regarding the evaluation of any specific information, opinion, advice, or other content. Of course, on all matters involving legal interpretations and regulatory issues, investors should consult legal counsel.

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