2015 Half Time Report

Greece – no comment as the story changes several times a day. A great lesson in lending.

China – in just three weeks, stocks listed on Mainland China’s most prominent exchange tumbled 30% from seven-year highs. The even more speculative ChiNext Index has lost 42% of its value over 21 days. If you shorted stocks you risked arrest. Many shareholders have been prohibited from selling. Other stocks have just stopped trading. This story is in an early development stage.

U.S.A. – The outlook for U.S. equities remains generally positive, but the market has seen a six-year bull run, including a rise in the Standard & Poor’s 500 Index of more than 200% without a meaningful correction. As a result, investors should expect higher levels of volatility in the near term.

June followed the May playbook that saw the broader indexes moving slightly higher before selling off at the end of the month. The bulls staged a modest comeback during June on positive economic news and the Fed’s dovish comments concerning an interest rate hike. Volatility has returned with a vengeance in early July as markets remain at or near all time highs. We have observed, as in the past, that there is a very low level of liquidity in the equity markets when faced with any meaningful and sustained selling. That’s a significant problem.

S&P 500 – July 2014 to July 2015

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MarketWatch reports that “with the Federal Reserve’s quantitative-easing program out of the picture, share buybacks are now the preferred way to boost stock prices in the face of softening earnings. But like QE, it is unclear how long the buyback boom can last.

In the first quarter of 2015, companies in the S&P 500 index returned more money to shareholders than they earned. The last time that happened was in the fourth quarter of 2008, when the entire S&P 500 reported a slight loss for the quarter but still spent $110 billion on dividends and buybacks.

What’s tethering executives to a reliance on share-count reduction has been the growth of stock-based compensation, so companies are under the gun to buy back shares to prevent dilution.

In the first quarter, S&P 500 companies spent $237.69 billion on dividends and buybacks, while reporting operating earnings of $228.36 billion, according to data compiled by S&P/Dow Jones.

Valuation: The S&P 500 is currently trading 16.5 times forward estimates of its companies’ earnings, according to recent data from Reuters. Forward estimates are an important metric that many analysts use to gauge the attractiveness of equity indexes. The S&P 500 is about 10 percent more expensive than its historic average of 15, according to Reuters estimates. Earnings multiples are only one half of their historic highs reached at the peak of the Dot.Com bubble in 1999.

Is the market overvalued? On an earnings basis – NO. In a rising rate environment – YES.

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We remain cautiously optimistic even as negative geopolitical and financial events continue to evolve. Perhaps the Fed will increase interest rates someday… perhaps. We look forward to it.

Have a great summer!

J. Brock Hamilton July 2015