It’s still a coupon-clipper’s market

The Lunar New Year holiday came at a good time for Chinese investors. This is the kind of market you want to sit out.

US stocks traded within narrow ranges for a second session on Monday. It will take the US market quite some time to digest the news of the past month, rather like a boa constrictor that has just ingested a whole hog. There isn’t much to add to what the market already knows, namely:

1) The Powell Fed is terrified to let air out of the quantitative-easing bubble because it fears that it will pop, as it seemed to do in December’s free-fall. Wall Street economists are quibbling about the rate of economic growth or inflation that might nudge the Fed into a rate increase next September, but for the time being the Fed has taken itself out of the game.

2) The US and China are sending signals that a trade deal is likely. I reported from Beijing in October that China was looking for a deal that would allow Trump to claim victory and have not changed my view. But we won’t get any more news until late February.

3) US economic growth remains supported by an annual gain of about 1.5% in employment, which translates into about 200,000 new jobs a month. Job growth is concentrated on the lower and less secure part of the employment spectrum, as listed companies shed 1 million jobs over the past year while small firms added over 3 million jobs. Employment gains bring less growth than they did in past recoveries, but the hiring momentum among small businesses remains strong, and puts a ceiling on US GDP growth in 2019.

4) The profits of US-listed companies for the first quarter are expected to fall year-on-year by 0.8%, as brokerage-house analysts revise their forecast downwards. Technology is forecast to fall the most, by 8.9% year-on-year. That doesn’t bode well for the stock market.

A big employment report on Friday drew nothing but yawns from US equity investors. So did President Trump’s statement during a Sunday television interview that trade talks with China are “doing very well” and there is a “good chance” of a deal.

The question is: Are US stocks worth the risk? The standard gauge of risk is the volatility (rolling standard deviation) of returns. The expected return divided by volatility is a standard measure of risk/reward (named after Nobel Prize winner William Sharpe).

I calculated expected returns for major sectors of the US stock market by adding the brokerage-house analysts’ consensus forecast of profit growth to the dividend yield. That’s shamanism, to be sure, since the brokerage-house analysts are making wild guesses, but it’s a starting point. Divide the expected returns by the volatility of each sector (I used the implied volatility of options on sector ETF’s), and you get the Sharpe Ratio, as on the adjacent table.

The results are pretty dismal. In each case, the standard deviation of returns is greater than the expected return. In other words, US stocks look too risky to be attractive in a low-growth, low-profit environment. By contrast, the largest high-yield bond ETF (JNK) has a yield of 5.6% and a volatility of 4.7%. That’s a better risk-reward than equities.

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