Singular Research List Reports Seventh Consecutive month of outperforming the S&P 500
One of the most noteworthy aspects of the current market and U.S. economy is the flattening of the yield curve. Despite an unrelenting campaign by the federal reserve to raise overnight rates, long term rates have not moved up but instead have more down. Rarely have investors been offered so little extra yield for tying up their money for longer periods of time. Three month T-Bills yield 3%, and 10 year Treasury Bonds yield just 3.92%. Market participants have different takes on this situation. On the one hand are those who remember from their training somewhere that a flat yield curve indicates slowing future economic growth and perhaps a recession on the horizon. While historically, this has been a decent forward looking indicator, I side with the other camp.
This camp believes that there are unique forces driving down long term interest rates in the U.S. The obvious force is the increasing reserves of U.S. government bonds being held by such foreign central banks as China and Japan. Indeed, this is usually framed as foreigners lending us the money to splurge on what we could not otherwise afford, and is told as a cautionary tale. In my opinion, however, this is a symptom of deeper economic forces at work. Why are foreign central banks buying up our national debt? The answer is they have excess dollars (foreign reserves) that need to be put to work, and stuffing it in the mattress doesn't cut it. Why do they have excess dollars? The short answer is they sell more goods and services to us than we do to them, in other words, they run a trade surplus with us.
And now we get at the nub of the problem. Why do they run a trade surplus with us? Is it because the Chinese peg their currency to the dollar? Is it because of trade barriers? While these may have some impact, the evidence leads me to believe that differing savings rates are the main culprit. Put simply, either Japanese and Chinese citizens save too much and do not spend enough or Americans spend too much and do not save enough. This savings imbalance is unleashing a flood of money looking for investments, and few places are as attractive as the Untied States with its better than average growth prospects, strong credit worthiness, clear rule of law, and protections for minority shareholders.
The decline in interest rates in the U.S. in the face of rising short-term rates is directly related to this flood of savings. Evidence from the TIPS market indicates it is not an inflation/deflation issue as real long term interest rates are falling both here and aboard. So what implications does this have for the U.S. equity market? First, while multiples are historically high, they should be high in an environment where interest rates are at 40 year lows. In a world of 4% risk-free rates, low beta firms will have single digit costs of capital.
Simple math tells us that the risk of rising interest rates outweigh the potential gains from rates falling even further. Nonetheless, until foreigners learn to spend more and save less, and as long as foreign economies are burdened by massive social welfare states which retard their growth relative to the U.S., there will be continued and sustained downward pressure on long-term U.S. interest rates. In such an environment, I believe that stocks will tread water and return mid single digit type performance. In other words, stock price appreciation will come from earnings growth not multiple expansion.
Which brings us back to the Singular Research List. Our companies have performed remarkably well over the last year, but in many cases the price appreciation was simply in line with growth in earnings per share. The following graph illustrates this point.
Few things in the stock market are certain, but the notion that stock prices eventually will follow earnings growth is about as close as we can come.
As the market mood switched from fear to greed in May, the most speculative stocks outperformed. Our research list was impacted by this development, specifically our two short calls NVEC, and TZOO. NVEC was up a startling 66.4% on no news. TZOO was up 19%, also on no news. We continue to recommend short positions in each of these names. Despite this setback, several of our long calls put in excellent monthly performances led by PARL up 48.3% on assumption of coverage by a competitor, ATRI up 37%, HANS up 31.5% and IRIS up 30%. For the month, the Singular Research List was up 4.18% versus the S&P 500's 2.91% performance, an outperformance of 127 bps. Year to Date, our research list has outperformed the S&P 500 by 19.2%