The Seven – Ten Split of Investing

The seven-ten split is widely considered the most difficult pin arrangement in bowling. You face one pin on the far right and one pin on the far left. There are no pins in between. The bowler must commit to one and in doing so hope to knock down both. The long-term chart comparing the S&P 500 with the S&P commodity index (GSCI) is starting to resemble a seven-ten split.

Over the last ten years we’ve seen a gradual, but consistent divergence between a rising S&P 500 and a falling commodity index. A quick glance might leave one thinking that the S&P 500 is the winning bet between the two indexes. However, there’s more to the picture.

Is a rising S&P 500 representative of sound fundamentals within the underlying equities? The cyclically adjusted price to earnings ratio (CAPE) shows valuations at near record highs. In fact, the only time we’ve seen valuations at this level have been in the lead up to the Wall Street crash and the dot-com bubble. Within just the last few months the Fed released a statement explaining their view that “Broad U.S. equity price indexes increased over the inter-meeting period, and some measures of valuations, such as price-to-earnings ratios, rose further above historical norms. … Some participants viewed equity prices as quite high relative to standard valuation measures.”

In an attempt to better understand the contextual weight of these comments researchers looked at six other instances where the Fed remarked on “overvaluation” since 1996. The data was revealing. They found that “The officials’ discussion of an overvalued stock market often came before long pauses during bull markets.” This assessment gives equity investors reason to pause but what does it mean for commodity investments?

The S&P Commodity Index, which includes precious metals like gold and silver appears to represent the mirror image of the S&P 500. In this case, commodities looked undervalued and poised for a resurgence. Katusa research has seized on this finding. They offer a blunt assessment that “Relatively speaking, commodities are dirt cheap. In fact, they are the cheapest they have ever been to the share prices that make up the S&P 500.”

Cautious investors will remind themselves that this comparison is a relative measure. That is, the opportunities for commodity investments may seem less robust when compared to indexes other than the S&P 500. However, the unassailable truth remains: commodities appear to be more fundamental-driven compared to equities which occasionally follow the capriciousness of flawed investor psychology.

Fortunately, investors can have it both ways. Investing in the S&P 500 certainly, doesn’t preclude exposure to commodities. The takeaway, however, is that the data shows today’s market is offering some valuable opportunities for inexpensive commodity investments largely ignored amid the fervor surrounding the bull market in equities. Consider buttressing your portfolio with the diversification that comes from an array of asset classes.

The data illustrates that opportunities for investors are never front and center. Rather, they exist in the margins where people aren’t looking. Look closer.