August 8, 2017

L&S Risk Pulse™ Score

Medium +

Core economic indicators are healthy, but markets indicate potential near-term volatility and/or mild correction. Valuations are trending high.

L&S Risk Pulse™ Insights – “The Song Remains the Same”

General Comments

At L&S, we are fond of saying that when the facts change, we will change, but in July the facts remained the same. As such, we continue to maintain the L&S Risk Pulse at Medium +. In June, we discussed the divergence between the “news” and the “data,” and July continued the same song. At L&S we ignore the news, and focus on the data. That’s not to say we don’t recognize that political and geopolitical risks remain high. Political gridlock, tax reform, healthcare repeal, Russian collusion, impeachment and now a nuclear Korea are important, but the relatively small market response to such news undermines the view that current market movements are completely explicable by the “news”.

Data Points and Global Economic Indicators

The data points continue to show improvement both domestically and geo-politically. Global growth is improving and earnings for Q2 were on average better than expected. Credit conditions remain sanguine. Credit spreads remain low, and show very little signs of stress or excess. Commodity prices are improving albeit at a glacial pace. Domestic GDP as well as European and Asian industrial production continue to accelerate from recession like levels of the past number of years.

Employment trends remain positive and supportive of economic expansion. However, technically, the markets are exhibiting some warning signs. Valuations are extended and markets are sitting at all time highs. Volatility is subdued-a contrary indicator. We remain cautious but itis hard for us to be negative in the face of the majority of the data points that remain supportive. We plan to redeploy any cash generated.

Conclusion

Here at L&S we continue to ignore the “news” and “talking heads” and instead have focused only upon market sentiment and economic data points. The equity markets appear pragmatic and focused on economic and corporate results, and so are we. While market sentiment and economic data points may lead one to conclude that we are complacent, we recognize that market valuations are trending high. The market for many remains very expensive and despite how well operating earnings have come in, pricing may be considered excessive. We have 19x forward earnings, 24x trailing reported earnings and the cyclically smoothed CAPE sits at 30x. Very few times has the market been so excessive in the past, and when this condition did exist, we were in the very late stages of a market cycle. We will “stick to our knittin” and keep focused on our risk management parameters.