Author: Swan Asset Management
Covestor models: Hedged Equity, Christian Agape Hedged Equity and International Hedged Equity
Treasury yields fell and credit spreads widened over the past few months. At the same time, yields on TIPS (Treasury Inflation Protected Securities) out to 10-year maturities dropped to negative levels. Lower yields and wider spreads both signal weaker economic conditions. When 10-year TIPS only compensate for inflation and provide no real return, investors are indicating that they see little chance for growth and want to at least maintain their purchasing power.
In a formula developed to help analyze value, legendary value investor Ben Graham suggested that a multiple of 8.5x earnings per share was an appropriate valuation level for stocks that lack growth prospects. When investors forecast little real economic growth, Graham’s no-growth multiple can be applied to the broader market. By this measure, the market is already significantly overvalued. Furthermore, that range would only hold in an environment in which earnings estimates are realized. Weakness in sovereign debt, European banks, and U.S. employment indicate a contracting global economy, where there is significant downside risk to both earnings estimates and the S&P 500.
The Christian Agape Hedged Equity, International Hedged Equity, and Hedged Equity models are all hedged to their maximum allocation. This posture has preserved value in the recent selloff. All three of our models significantly outperformed their benchmarks in August.
If the market takes another step down, we will begin to take gains on these SPXU hedges and redeploy proceeds into equities trading at lower, more attractive levels.
