I am quite concerned.
At the most basic level, 12 years ago the total market cap of all US stocks added up to less than 60% of American GDP.
Put another way, you could buy the stock market with 60% of what the economy produced that year (2008).
Now though, the market cap is 200% of US GDP. It’s gone from roughly half the price, to double – almost a quadrupling in the price paid for each unit of the economy – driven by shifts in investor psychology.
This very basic measure tells us how expensive stocks are relative to the strength of the economy in which those companies take part, and it’s at record levels, all-time highs.
However, not all countries’ stock markets are so overvalued. And not all assets are so richly priced.
Last week, I read the latest monthly issue of Dynamic Investment Trends Alert.
Its editors, Rashpal Sohan and Robin Griffiths, run an investment portfolio driven by the APLH4 Model.
Robin is head of the Multi-Asset Research & Advisory team at the ECU Group – an award-winning global macro research, advisory and investment firm, and Rashpal is Senior Macro & Quantitative Strategist at ECU.
In short, as Rashpal and Robin explain:
The “ALPH4” system ranks a list of important assets using our proprietary trend ranking methodology. Some assets do better in times of Fear and others in times of Greed. Our model tells us which assets to buy each month.
ALPH4 outputs the complete list of ranked assets divided into 5 groups: Strongest, Strong, Neutral, Weak and Weakest…
The list is updated monthly and any changes to the list need to be mirrored in our portfolio… These trends do not change as rapidly as those for individual shares and typically means holding four assets each month.
As humans we are bound to fall into the traps of overconfidence and inertia.
I.e., I probably believe in my own thesis too much, and am slow to adapt it to new information.
I’m not brilliant at doing this, but I try to give credit to arguments which challenge my own views.
The APLH4 Model is also a phenomenal sense check, and with all this in mind, Rashpal kindly allowed me to share some of their latest findings and insights from the model.
It is seeing things like emerging markets and commodities as the strongest assets for the moment, which makes sense. But the model is in full risk-on mode, with gold relegated to the weakest section. Below is the commentary and some of the relative strength measures.
President Biden has kicked off his presidency by injecting $1.9 trillion into the US economy. This is about 9% of US GDP. This of course follows on from the 5% injection made by Mr Trump. The world is awash with cash. As a result, both the OECD and IMF estimate that the global economy will grow around 5.5% this year. This is a huge rate of growth and will take the economy back up to where it was before Covid-19 came along.
Whilst the US Federal Reserve may be the largest and most important central bank, we can see that taken in aggregate, the balance sheets of the four largest central banks still continues to grow. At the same time, globally most central banks remain in rate-cutting mode. Historically, rate cuts lead global economic growth by around four months. So it should come as no surprise then that global economic growth is picking up with this much monetary easing going around.
By plotting a leading indicator of global economic growth against the US dollar, a very important truth emerges: super-fast growth leads to a weak dollar. Consequently, with global economic growth accelerating, the US dollar continues to remain under pressure.
The very strong growth and weak US dollar tend to make commodity prices rise faster. In fact, the currencies of markets dominated by commodities such as Canada, New Zealand and Australia are beating the US dollar easily.
This same growth scenario makes for stronger economic growth in emerging markets. The equity markets of these countries are outperforming developed market equities and the currencies of these markets are also beating the US dollar. As a result, these equity markets are the strongest in the ALPH4 Model and investors get a double boon when investing in these markets.
As global economic growth continues to accelerate, it is quite normal for the yield on government bonds to continue to rise and their prices to fall. This is indeed happening now and has been picked up by our model. The strongest assets are high-risk emerging and commodity prices and the weakest assets are falling bond prices. The signals are coherent in all the charts we monitor.
The ALPH4 Model performance is computed holding only the top four strongest assets in the ranking table. However, we have in the past tested holding the top two groups (Strongest and Strong assets) to spread risk wider and gain a better risk-adjusted return. You will notice that in the Strong asset group we have other equity markets: Europe, Japan and UK are there. We also notice world equities and then finally the US equity market.
The US is there as the weakest of the markets in the Strong section. However, it is below the world equity group, so to own the US equity market, you have to take more risk than owning the entire world equity market for a slightly lower reward. This coupled with the primary message that rapid global economic growth goes hand-in-hand with a weak US dollar, we are encouraged not to own US equities.
The model is fantastic at cutting through the noise in times of great uncertainty such as now, and it can adapt relatively quickly to big turnarounds.
Sometimes inertia is an investor’s worst enemy, and I find the ALPH4 Model a great way of seeing if my views match what assets are actually doing well right now.
Reading that confirms we’re on the right track in steering clear of most US equities, and looking towards value and commodities, but suggests that I could be a bit more forgiving of other equity markets.
Going back to the market cap-to-GDP figures from earlier, while the US is at very extreme levels (201%), here in the UK we come in at a reasonable 100%, and others do even better – India (86%), Germany (52%) and Italy (34%) are all candidates for our interest on this metric.
It also suggests that we are in a tough period for gold, but I continue to find the long-term prospects just so compelling. Time will tell…
All the best for now,
Editor, UK Uncensored