Broker Check

The Great Normalization

| July 02, 2014
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What does “normal” mean when it comes to stock and bond market returns?

All over the globe, we are seeing more military tension, economic disputes and regional conflicts than at any time since the Cold War. The rising trend in nationalism over globalization is disturbing. Despite these facts, when it comes to business, the second half of 2014 and 2015 are likely to see the combined forces of capitalism and innovation serve as significant drivers to domestic growth.

Potential drivers of growth in the United States: 

1.      U.S. Housing – a long road back to normal;

2.      Domestic energy:  North America appears to be rapidly approaching energy independence;

3.      U.S. Manufacturing:  potential job growth over the next decade is 2-3 million;

Example:  Caterpillar will build a factory in Bogart, GA and expand an existing facility in Sumter, SC to create additional manufacturing jobs; 

4.      Significant advances in biotechnology;

5.      3D printing.

I have been receiving these three questions a lot lately: 

1.      What kind of returns do you expect from stocks and from bonds?

2.      What are interest rates going to do?

3.      When is the right time to pull out of stocks?


Here are some thoughts on “normalization”, as the Fed exits Q.E., and inflation and wage growth continue to firm and increase…

We will most likely see:

Equity market returns likely exceeding bond market returns.

Equity market corrections occurring at a normal frequency (these are historic averages): 

·         Three corrections per year greater than 5%;

·         One correction per year greater than 10%;

·         One correction every three years greater than 20%

Bond market returns will likely be modest, but positive – although many bond prices face a tough road ahead as rates normalize.

Bonds should provide significant diversification benefits and act as a cushion against equity market corrections.

Replay of President's Day weekend 2008

There will be a liquidity problem with certain bonds at some point in the near future as treasury market yields normalize and the Fed begins to raise the Fed Funds rate, so you must have a discipline as to what you want to own and why.

Many popular parts of the stock market are trading with excessive price/sales valuations and may not see very positive performance results over the next several years so you want to avoid those parts of the market.

Example: Cisco Systems in January 2000 (was so popular then, but was then trading with excessive price/sales valuation; good stock to buy now, however, 14 years later and with a nice, growing dividend).

Made in the U.S.A. Or China?

Our family was up in the mountains at a family 4'th of July gathering and the kids wore an American Flag hat that came from WalMart and cost $1. Where do you think it was made? Of course...China. Well, this is a chart I thought many folks might find interesting...

This is a chart of the change in real unit labor costs since Q1 2002. China's labor cost advantage is not as stark as it once was and those cheap hats may be produced in China, but the good, old, U.S., of A., is seeing our share of value-add manufacturing growth. That growth will not translate to the huge number of jobs it did in past decades due to advances in robotics, but it's still positive to GDP growth.

Change in Real Unit Labor Costs Since Q1 2002:



 


For an expanded look at “The Great Normalization”, go to:

https://www.vickerycreek.net/p/investment-themes-2014

-Jack Parsons/President & Chief Investment Officer

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