Investors and spectators of the global financial markets come to quickly realize that the markets are fastpaced and the supporting fundamentals are very dynamic.
Investments that were popular and looked promising over the past decade, past several years, past year and even past week could lose their appeal due to changes in outlook, but with the change in investment vogue comes opportunity. After reviewing the current market, it seems that one thing that is missing is a good variety of undervalued investment options.
One of the best ways to determine if assets are under, evenly or overly valued is by using history as a guide. For example, from a historical perspective, examining the equity, fixed income, and commodities market, each of these markets seem either fairly valued or potentially overvalued.
Equities in the U.S. are trading with Price/Earnings ratios of around 14-16 with dividend yields of 2.0-2.5 percent. This would put the valuation based on earnings and the pay-out ratio close to or slightly above its historic 40-year average. Also, taking into consideration the recent performance as of mid-September, the Dow Jones has returned almost 16 percent year-to-date, while the S&P 500 and Nasdaq have returned 18 percent and 23 percent, respectively. With consecutive positive returns year over year in the U.S. for the past five years, almost all in the double digits, it makes one wonder how much more the equity market will continue to rise over the remaining part of the year without some sort of a pull-back.
Although, if an asset class is overvalued, it doesn’t necessarily mean that you should completely avoid the allocation, but would suggest a prudent managed approach of holding less of an allocation or having a defensive tilt to what you are investing in. For example, in equities, if the stock market seems overbought, it is best to either start to reduce the position or restructure the portfolio toward a weighting of lower beta stocks, such as consumer staples, which typically don’t react as dramatically to downturns in the market.
U.S.Treasury yields increase
With U.S. Treasury yields starting to increase, they are looking slightly more attractive, with five-year yields increasing over the past few months from 0.65 percent in May to around 1.8 percent at the beginning of September. From a historical perspective, the average yield for a five year Treasury over the past 20 years has been approximately 4 percent. In this case, most investors would agree that fixed income is generally overvalued at this time. If you need to keep money safe and you would like to receive some compensation, then it would be best to invest in a bond ladder with a shorter average duration than typical.
Even commodity prices, such as oil with a price higher than $105 a barrel, seem a bit excessive given that the cost to extract, refine and transport is much less than this price. The high price is attributed to the rising optimism about global growth, outages in supply and concerns about possible U.S.-led airstrikes on Syria.
With most analysts reviewing the average price of oil being around $92 a barrel over the past 10 years, it does not come as a surprise that many analysts project that oil prices will drop below $100 by year end. Most analysts cite the reason as tensions over Syria fading or alternatively, the U.S. and its allies releasing oil from their strategic reserves.
Even industrial metals do not seem like a very good investment as prices should continue to fall even if global growth picks up. This is because the Chinese economy, which accounts for a large proportion of global metals consumption, is set to slow again in 2014.
Given all of this, as an investor, it is very difficult to navigate the markets in times like this. The best suggestion, aside from the ones mentioned above, is to start accumulating cash so that when there is an opportunity in the stock or the bond market, you have the flexibility to take advantage of it.
Many investors seem focused on being fully invested at all times. One of the best allocations an investor can make in uncertain times or markets that are overbought is to maintain a high degree of flexibility by having a healthy allocation toward cash.