The S&P 500 sold off two weeks ago, losing 1.72%. Energy was the hardest hit, declining close to 7%, followed by materials, which was down 3.77%. Defensive sectors such as Staples and Telecom were flat or only down slightly. The overall market traded basically flat last week until a Friday sell off closed it out near its recent lows.
So much for the very short term action. Longer term the S&P 500 is trading 45% above fair value, according to Jeremy Grantham of GMO ($108 billion under management), who pegs fair value at 920 for the S&P 500. Grantham’s estimate of fair value gibes with both Tobin’s Q and Shiller’s P/E (very good long term measures of stock market fair value). All of which means equity investors are still playing with fire. Hide out in bonds? Not Treasury bonds, at least not according to Bill Gross of Pimco fame. Bill has informed the world that Pimco has sold all of its Treasury holdings ahead of the end of QE2 (set to finish up at the end of June).
Grantham had thought that the combination of QE2 and the third year of the presidential cycle could push the S&P 500 back to between 1400 and 1600 by October of this year – putting it back into bubble territory. (Grantham is a student of bubbles in various asset classes throughout history and measures them against average valuations. He uses a two standard deviation divergence from long-term fair value to mark a bubble – what is supposed to be a once in 44 year event). Grantham now thinks it much less likely that the S&P 500 will reach the 1400-1600 level by fall, given its failure to advance farther by now. Historically, the market has advance 20% in the first seven months of the third year of the Presidential cycle (started last October). The entire return, on average, for the 48 month cycle is only 21%, meaning investors can expect a whopping 1% return from the S&P 500 over the next 41 months based solely on the Presidential cycle. Of course, these are only averages for the Presidential cycle and don’t take into account things like the current overvalued state of the market or the current jobless recovery (negatives for likely future returns.)
Bottom line for investors (and yep I know I’m starting to sound like a broken record) is that the market remains very overpriced and a dangerous place to be right now. Healthy levels of cash will ensure that any 20% to 30% decline from current levels in the next few years will make it possible to buy cheap assets that will provide above market rates of return going forward.
Biechele Royce Advisors continues to buy good companies at great prices as we find them. We are holding extra cash in clients’ portfolios for the inevitable rainy day that is coming, likely in the next 12 to 24 months.