The financial gods were kind again to the major asset classes in July. Everything was up, and mostly with strong gains.
As our table below shows, it was hard to lose money last month, a.k.a. a refreshing change from the recent past. Of course, if you were sitting mostly in cash, there was little to celebrate with a virtual zero to the month’s total return for 3-month T-bills. Inflation-linked Treasuries didn’t do much better, but everything else did.
Emerging market stocks were the big winner, closely followed by REITs, foreign developed market and U.S. equities. Risk, in other words, paid off quite handsomely in July. With such widespread gains of more than modest means, our Global Market Index—a passively allocated mix of the major asset classes—also posted a strong total return of 5.5% last month.
In fact, the capital and commodity markets have been rallying since March. Granted, the performance in June was mixed and unimpressive, but generally speaking otherwise the returns have been positive for much of the past five months. The question now is whether the rally was/is 1) a reaction to the realization that the darkest fears of last year and early 2009 were exaggerated; or 2) an expectation that a meaningful economic rebound is imminent.
If the answer is 2, and the crowd believes strong economic growth is near, a bit of an attitude adjustment may be in order. Meanwhile, for those who are still buying in recognition that the global economy will survive, albeit in somewhat hobbled form, it’s not clear that the trade has further to run on that reasoning alone. It is, to be blunt, a bit late in the day for rationalizing higher prices solely on the basis of #2 above.
U.S. stocks, for instance, are thought by some to be at fair value vs. the relative bargain pricing that prevailed early this year. And that’s the optimistic view. Indeed, economist Andrew Smithers estimates that U.S. equities are 20% overvalued, The Economist reported last week.
As we’ve been discussing for some time, including here and here, our view is that the gap between the technical end of the recession and the arrival of a robust economic rebound will be unusually long this time around. Does the crowd agree? It’s hard to say exactly, although we’re erring on the side of caution by holding a bit more cash than we otherwise might be if this was a “normal” business cycle.
Yes, the rally this year is warranted, but it’s getting harder to argue for rising asset prices without a commensurate change in the macroeconomic fortunes. That will come eventually, but as Friday’s GDP report for Q2 suggests, it’s going to take time, perhaps more time than the crowd currently realizes.