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Are the Markets Overvalued?

Are the markets overvalued?  In my view, the answer is data dependent.  Relatively speaking shares are inexpensive based upon current interest rates.  On the other hand, if rates begin to normalize, values are extended.

The Federal Reserve has stated any changes in monetary policy will be data dependent; an answer I think is the only one that can be offered.

Sovereign debt—including treasuries—have traded lower in price in recent weeks as global data is suggesting deflation is no longer a threat.

Has inflation turned higher?  The issue at hand is that rates are extraordinarily low.  The financial system is awash with stimuli but the debt markets are becoming more illiquid given mandatory changes in trading technicalities and the proliferation of ETFs.

If the data is decidedly stronger than anticipated, data that may suggest a change in inflationary expectations, the bond market can be routed which then would impact equity prices.

Call me old fashioned, I believe the fixed income markets dictates the direction of equities, not vice versa.  If rates move decidedly higher, defined as a 3.0% 10-year Treasury and remain at these yields, equities in my view are now overvalued.  Ifrates continue their ascent, equities would then begin to become vastly overvalued.

All must remember there are two primary components of valuation models; cash flow discounted by some interest rate.  For the last five years, both were equity positive.  However beginning with this year’s first quarter, the cash flow component turned negative.  Is the interest rate component turning negative?

It depends upon the data.

I am not suggesting equities will slip into a deep bear market, albeit a case can be made the typical stock is already in a bear market due to the domination of algorithmic traders and ETFs which are essentially closet index funds that have made the last 14-16 months difficult.

I think the markets may be in the infancy of another transition where the individual stock outperforms the index.  This view is shared by Goldman for last week Goldman wrote for the first time since 2012 the typical active money manager in April outperformed the indexers—indexers in both name and behavior.

Last night the foreign markets were mixed.  London was up 0.36%, Paris down 0.10% and Frankfurt down 0.20%.  Japan was up 0.06%and Hang Sang down 1.31%.

The Dow should open little changed ahead of the ISM non-manufacturing index and nervousness emanating from the release of various employment statistics during the next several days. The 10-year is up 6/32 to yield 2.12%.

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Ken Engelke

Chief Economic Strategist Managing Director

The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. This material is being provided for informational purposes only. Any information should not be deemed a recommendation to buy, hold or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. This report is not a complete description of the securities, markets, or developments referred to in this material and does not include all available data necessary for making an investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. If you would like to unsubscribe from this e-mail distribution, please reply to this e-mail and indicate that you wish to unsubscribe in your response.