THE COOL WINDS OF JUNE

The weather in June was cool and rainy in the New York region, and something similar prevailed over the capital and commodity markets last month as well.

As our table below shows, June was a month of mixed messages, ranging from a healthy rally in high-yield bonds to loss in REITs. Disappointing, perhaps, given the previous bout of good times. But the arrival of red ink is hardly unexpected. The March-to-May rally, after all, elevated all the major asset classes by dramatic levels. That couldn’t last. But what comes next?

The optimistic interpretation is that June was a month of backing and filling. The markets are reportedly digesting the recent gains and building a foundation to capitalize on the expected economic recovery. Prices got ahead of themselves in recent months, and bit of profit-taking was inevitable.

A less-forgiving outlook is that the recent rally in almost everything was a sucker’s game. The great bear market of 2008 is still with us, runs this line of thinking, and so the rest of the year will suffer.

Your editor tends to come down in the middle of these two extremes. As we’ve been pointing out in more detail in recent issues of The Beta Investment Report, the foreseeable future for returns in the major asset classes looks increasingly unexceptional. The sharp snapback in prices so far this year looks warranted as it became clear that the worst fears for the economy were overdone. All the more so as it appears that the technical end of the recession may be near.

Then again, we can’t be sure. There are still lots of reasons to remain cautious. Forecasts, after all, are created by mere mortals and so predictions are subject to revisions as new information arrives. Meanwhile, the stock market looks fairly valued at the moment, which is to say that it’s no longer undervalued, as it was as this year opened. Similarly, yield spreads, while still attractive, are no longer extraordinarily high.

In short, the markets have rallied on the expectation that the aggressive liquidity injections of governments around the world would bring stability and, eventually, expansion. That still looks like a good bet, but no longer are markets offering massive discounted prices tied to that outlook.

Then again, none of this is a surprise. Expected returns vary, as they must in order to attract buyers through time. No one would be willing to buy risky assets in January 2009 without an unusually high expected risk premium. Now that the macroeconomic risk looks lower, albeit still substantial, assets are priced accordingly.