If there is one word to describe the US stock market in the third quarter, it is volatility. As we say in the business, vol was high. Will higher vol continue into the fourth quarter and next year? We think the answer is 'yes'. The reason is that interest rates around the world are distorted by the monetary policies of central banks. Regardless of what our Fed does in the fourth quarter of 2015 and in 2016, this global distortion is in place and will remain so for years. Thus vol is destined to be higher than we like it to be, and it will be disconcerting when it spikes up.
Does higher vol mean a bear market? We think the answer is 'no'. Bear markets are established when there is a recession; the stock market usually leads it. Or we get bear markets when there is an inverted yield curve (longer rates are lower than shorter rates). Yield curve inversions are the market’s way of forecasting negative changes coming in the economy and of measuring tightening monetary conditions.
We do not have an inverted yield curve. That one is easy to measure.
As for recession versus slowdown versus pick-up, there is an ongoing debate. We are in and have been in the slow-recovery, low-inflation camp. The US economy is not robust, but it is not shrinking. In the US 2.5 to 3 million new jobs are being created annually. The incomes of workers are slowly improving. Inflation is low – between 1% and 2%, depending on which measure we choose. 2016 is not likely to be much different.
So the US stock market shapes up to a “first call consensus 2016 operating earnings estimate for the S&P 500 index of $132” (source, Strategas). These forward estimates suggest a 15 P/E multiple level on the S&P. A 15 multiple means an earnings yield of almost 7%. Compare that with the riskless ten-year Treasury yield of 2.2% or 2.4%, and stocks look attractive. We think so.
This long bull market started on March 9, 2009, with a panic-selling low price of less than 700 on the S&P 500 Index. This is now the third longest bull market in modern history (since 1928). The longest (1990-2000) lasted ten years. The second longest (1949-1956) lasted seven years. To quote Yogi, “It ain’t over till it’s over.” We remain on the invested side as we enter the fourth quarter. After rising vol come higher stock prices.
David R. Kotok, Chairman and Chief Investment Officer.