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%.
