2014 Q2 Letter: Are US Equities Reaching a Top?

The second quarter of 2014 saw global markets rise after shrugging off a number of geo-political concerns clustered primarily around the middle-east (Ukraine, Egypt, Turkey, Iraq, Palestine). Stocks and bonds in the US have continued their march upwards with the S&P 500 and Dow Jones indices scaling all-time highs. There is some speculation that turmoil in Asia and Eastern Europe has driven investors to seek the relative security of US-based assets, including stocks, bonds and real-estate.  While this is anecdotal, we do see signs of foreign investments boosting asset prices in each of these markets.

We continue to advise caution to equity investors. The S&P 500 is trading at 19 times last year’s earnings, while the Nasdaq composite index is over 23. Longer term measures of value (such as the Cyclically Adjusted P/E) are close to levels reached at the peak of 2007. Though it is not possible to say exactly when a decline might begin, hazard signs are clearly visible and we think risk should be considered when looking at portfolio allocations.

Stocks have been buoyed by the low-interest rate policies still being followed by most central banks. With short-term rates close to zero, holding cash remains an unattractive proposition for investors and has led many to conclude that stocks are a relative bargain, even with very small anticipated returns.

Bonds offer little respite for investors. Due to continuing loose monetary policy by central banks, interest rates are close to historic lows. Long term bonds offer very little by way of return potential. 30 year treasuries are offering a 3.4% yield and 10 year treasuries are at 2.58%. These are meager returns for considerable risk since we anticipate the Fed will continue to reduce bond purchases and begin raising rates next year.  Long term bonds perform very poorly in a rising rate environment.

So where are the investment opportunities?  There aren’t many areas where we see a lot of value.  We continue to prefer high quality, dividend paying stocks both domestically and internationally.  For bonds, we prefer short term and floating rate issues as well as certain foreign sovereigns.  There are a few general investment themes that we still find compelling like alternative energy, energy efficiency, water resources and healthcare-related companies.  But, in general, we think an allocation weighted towards asset preservation is advisable.

In other news, Louis had a second article published by Green Tech Media on the topic of clean energy YieldCos.  You can read the article here.