Valuations

We’ve been negative on industrial commodities for some time, reflecting the persistently (and unsustainably) high levels of investment evidenced by our Global Group analyses of commodity-oriented industries.

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The United States’ large P/E premium relative to the rest of the world suggests that foreign equities should produce total returns of about two percentage points (annualized) above the U.S. over a seven to ten-year horizon.

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Small Cap Premium Slumps To 17%

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Low Quality Momentum persists, and a look at how Valuation factors affect the Quality model output.

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Small Caps have staged a nice rebound in the last several weeks. On July 3rd, the Russell 2000 rose to within a fraction of an index point of its March 4th all-time high. But on a relative strength basis, the bounce has been pretty muted.

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We’ve been negative on commodities and most commodity-oriented equities for the last three years, believing that the magnitude of the ramp-up in commodity production capacity over the last decade remains generally underappreciated by investors.

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Current conditions remain cyclically bullish for equities, however, the mathematics don’t support the  “secular” bull market thesis, or those betting that stocks can be propped up by the economic expansion.

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Unfortunately, the upswing since early 2009 can be considered immature only from the perspective of its age. The math just doesn’t support the secular case.

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Although the social media darlings haven’t recouped their losses, the Technology Index moved to new cycle highs in early June.

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Small Caps are selling at a 17% valuation premium relative to Large Caps (19% last month), using non-normalized trailing operating earnings. The Small Cap sell-off over the last three months has pushed us away from the recent peak premium of 23%.

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Today may feel different, but it isn’t. The past 13 months’ trading action in the U.S. is the second example of this phenomenon in the current (2009-to-date) cyclical bull market. We focus on 11 previous episodes for perspective. Plus we clarify recent thoughts on interest rates and stock market valuations.

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We’ve written before about retail investors’ tendency to “conflate” stock market action with movements in the underlying economy. Misunderstanding this interrelationship generally causes the public to liquidate stocks when the economy is weak, only to ultimately buy them back when the economic recovery is obvious to all.

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Health Care and Consumer Staples valuations don’t look as dangerous as widely assumed. Utilities look expensive; conversely, the big corrections in the Industrials and Materials sectors have yet to create truly compelling valuations. The best sector for contrarians is Energy.

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Taking into account the variety of total return contributors, we conclude that no one regional equity market stands out as a slam dunk investment idea.

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A new dividend growth screen and another that additionally incorporates dividend growth at a reasonable price are explored.

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An interesting take on country demographics versus valuations.

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Valuations are sliced and explored from a different angle.

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U.S. equity investors were disappointed in 2011, but we’d point out they fared better than investors in 45 of 48 other countries tracked by MSCI.

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Major Trend Index fell to Negative at beginning of August. Assumption is that we are now in the beginning of a cyclical bear market that may produce a 20%-25% loss within the next six months or so.

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