As of last week, the Market Climate for stocks was characterized by moderately unfavorable valuations and mixed market action. We estimate that the S&P 500 Index is currently priced to deliver annual returns over the next decade of about 7%, which except for the period since 1990 is generally a prospective rate of return consistent with market peaks, not troughs. Still, stocks look less expensive if one assumes a permanent return to 2007 profit margins, which were about 50% above historical norms. We can’t rule out the potential for investors to invest on unreasonable and largely unfounded expectations of a return to those earnings levels, which could provoke a continued willingness to pay what in our view are already elevated valuations.
From the standpoint of market action, price-volume sponsorship continues to be decidedly tepid. Indeed, trading volume on the NYSE has declined sequentially in every month since March. The market is strenuously overbought over the short term and fundamentally overvalued on long-term measures, but unfortunately, we can’t stand in front of investors and say, no, stop, don’t. The Strategic Growth Fund holds just under 1% of assets in index call options as an anti-hedge to soften its defensive position in the event the market advances further. Otherwise the Fund is well hedged. As is typically the case when the Fund is hedged, the bulk of our returns here will be driven by the difference in performance between the stocks held by the Fund and the indices we use to hedge. On that front, I am very comfortable with the Fund’s holdings, and continue the day-to-day practice of buying higher ranked candidates on short-term weakness and selling lower-ranked holdings on short-term strength, consistently looking to build favorable valuation and market action into the Fund’s portfolio in that way.
In bonds, the Market Climate last week was characterized by slightly unfavorable yield levels and slightly unfavorable yield pressures. The Strategic Total Return Fund continues to carry a duration of about 3 years, mostly in TIPS, with less than 20% of assets allocated toward precious metals shares, foreign currencies, and utility shares. In continue to expect that the U.S. dollar will face significant pressure in the coming years as the combined result of an unsustainably wide current account deficit coupled with aggressive issuance of U.S. government liabilities. Though I don’t expect near term inflation pressures, the supply of government liabilities alone have weighed on the dollar. Our investment stance in the Strategic Total Return Fund is primarily concerned with increasing purchasing power over time, and our primary activities in the current low yield environment will continue to involve adding to our exposures in bonds, precious metals and currencies on price weakness, and clipping that exposure on strength, as we don’t anticipate strong and sustained directional movement in any of these asset classes until inflation pressures emerge.
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