Three Market Metrics that Stand Out

by Wayne Ferbert on October 9th, 2013

We are going to start a new recurring article on this blog: the Three Market Metrics that stand out the most to me. Sometimes, these metrics will reflect what is happening in the market RIGHT NOW. And sometimes these will be metrics that are longer term in nature.
Let’s get started:
Metric #1: VIX goes over 21 – albeit briefly
Volatility is on the increase as Washington fans the flames of uncertainty. The VIX is at 19 and change right now. Which is very high compared to its average range this year. The 20-day simple moving average for the VIX has been below 15 for most of the year.
This means you can get more for your short options – and you must pay more for your long options. Obviously, hedging has gotten more expensive as a result.
Metric #2: S&P500 Price to Earnings at 15+
The Price to Earnings on the S&P 500 recently reached 15.5x. We hardly find 15.5X to be dramatically out of line with historic multiples.
So, while we expect the mess in Washington and the general slow economy to put pressure on the markets, we have seen markets trade at significantly higher PE multiples. It will be interesting to see what happens in the next earnings season to determine if this is a fair price or not. We’ll need to see some real earnings growth in this quarter to believe that $120 per S&P500 share is reachable in 2014.

Of course, whether we see pressure on the PE multiple will depend alot on whether real interest rates increase or not. If they do, investor expected returns will need to go up. So, I am watching interest rates also ...
Metric #3: Spread between Corporate Bonds & Treasuries
The Fed announcement in May of the coming Taper sent rates markedly higher – by over 1 point for 10 year Corporate A grade bonds. Only to see the yields pull back about 20 bps since the Taper was officially delayed.
When you look at the difference in yields between Corporate A grade and Treasuries for 10 year bonds, we see the difference at about 120 bps à 3.8% vs. 2.6%, respectively.
Back on May 1st, before the taper was coming announcement, the spread was 100 bps. As rates have gone up, the spread has increased. Interestingly, on September 1st, before the delay was announced on taper, the spread was 110 bps. And now since the delay, the spread has widened to 120 bps.
This movement could just be a temporary displacement. But I suspect something else. I think the market is voting with its wallet. I think that while the Fed is committed to keeping the risk-free rate of investment low, it will struggle to keep the Corporates and High yield market from starting to creep up.
If the market has a different view of the economy than the Fed, it can move rates – regardless of what the Fed believes it controls. Don’t get me wrong – the Fed can significantly influence the rates for everyone. After all, rates all start with the ‘risk-free’ return expectation.
But the market is craving a more normalized spread difference between these categories – and I think it will get it thru market pricing.
It is mostly a hunch – but one that I am following closely.

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