Risk Outpaces Reward in the Current Market

“I suspect we may be near or at least very soon approaching the peak,” opined a friend over lunch.

What peak? Where? And when?

More on that below…

Stocks are getting clobbered again today, Fellow Reckoner. The Dow was down another 150 points last we checked, giving back all of yesterday’s fleeting, counter-trend gains…and then some.

By our reckoning, yesterday was one of only a half dozen or so “up” days for the month…against a whole lotta down…down…down days — about 770 points down, to be not-quite-exact.

“Sell in May and Go Away!” proclaim the old hats.

As it turns out, the best day to sell your stocks this month was the very first day, May Day. If you did so, you could have pocketed the cash… waited…and bought all your shares back today for a 5% discount.

Sounds pretty good, right? Except for one, increasingly obvious problem…now you have all your shares back!

If stocks (with the benefit of hindsight) were a prudent “sell” one month ago, what makes them a hopeful “buy” today? A 5% discount? Doesn’t seem like much of an incentive to us.

As we know, investors get paid to shoulder risk…the “risk premium,” as they say. It’s the “minimum amount of money by which the expected return on a risky asset must exceed the known return on a risk-free asset.” So what are the risks involved for investors today vs. a month ago? Are things more, or less, volatile? A quick look at Europe seems to argue for the former case.

Yields on 10-year Spanish bonds blew out to a euro-era high on Wednesday. That’s not good. Analysts seem to agree (for whatever that’s worth) that a yield of 7% is unsustainable for a country to finance itself over the long term (whatever that means). This morning, the yield on Spain’s 10-year bonds was 6.67%.

The spread between the yield on Spanish bonds and German “safe-haven” bonds also reached a record — 5.6%.

Oh, and yields on Italy’s 10-year bonds also crept up over 6% — the first time they’ve done so since January.

Meanwhile, Greece is…well, Greece is toast, a crisis vacation hotspot at best. News in this morning shows the National Bank of Greece, the olive-squeezers’ biggest lender, registered a 1st quarter loss of 537 million euro. If you’re surprised at this, the latest in a string of “disappointments,” you’ve either had too much ouzo…or not nearly enough.

All this suggests that investors are coming to the conclusion — slowly — that we first aired in these pages some years ago. Your academically unwashed editor remembers penning a piece about the crack up of the euro back when he was burning joss paper and dunking dumplings in Taipei’s backstreet BBQ dives. Must’ve been 2010, the year of the Tiger. We were almost embarrassed at the time to write about the possibility of the spendthrift PIIGS tearing the continent asunder…but only because we thought we were late on the story.

Yet here we are, two years later, and the bobble head politicians are still reading, flaccid mandibles flapping in the breeze, from their dog-eared playbooks of fiscal claptrap and economic voodoo. Worse still, their words are reported, quoted and swallowed without even a garnish of irony.

Not that Europe boasts a uniquely “doomy” forecast. This, from the WSJ:

With the latest reports, a new economic threat is emerging: That activity is slowing in sync around the globe and not just in a few markets with their own isolated problems. Europe, struggling with the risk of a Greek pullout from the euro area and broader fiscal problems, is the epicenter of global economic concerns right now. But reports of economic trouble are turning up in China, India, South Africa, Brazil and elsewhere.

A “synchronized global slowdown” Bill called it in yesterday’s issue. “Bummer!”

No, Fellow Reckoner, a 5% discount should not be enough to entice you back into the game. Stocks on the S&P 500 still drag around with them an optimistic (read: delusional) p/e ratio of roughly 15. Value investors would like to see that cut in half before they even get their ankles wet.

Joel Bowman
for The Daily Reckoning