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Big Changes

There are some big things happening in the market suddenly. If they hold and persist, investors will have many more options to make money in 2016 than current sentiment would imply. Here’s what’s happening and where those opportunities are developing.

 

US Dollar Just Broke Down

 

The theme of the rising US dollar has been one of the most widely covered topics in the financial media. Corporations have blamed the strengthening dollar for much of their earnings erosion for the last 6-7 quarters including the current one. The entire commodities, energy, industrials and materials complex has also pointed to the rising dollar as a headwind to their profits. Likewise investors have watched their US dollar based international investments experience true bear market losses. The rising US dollar has also put a lid on bond performance across all maturities as well as other interest sensitive sectors like Utilities as investors responded to the risks of higher rates (the Federal Reserve). Currently, there is real sensitivity to the strong dollar and rising rates as our economic recovery is just not strong enough to handle these headwinds yet. Later, these won’t be as much of an issue. In the short term, the rising trend of the US dollar seems to have come to swift end with yesterday’s 1.6% plunge and break of the intermediate term trend.

 

Currency trends tend to track the economy for any given country. For the last 5-6 years, we have seen the US dollar stabilize and begin to rise strongly indicating the US economy was moving from recovery to actual growth. Now, the US economy is clearly getting weaker but is not recessionary (yet) and thus it makes sense that the US dollar would follow the economy lower. We don’t know if the US will slip into recession but it is angling that way. What we do know is that the market has corrected significantly already, enormously in certain sectors and indices, and may be approaching a buy zone as early as March or April. There are opportunities developing now on the back of a weaker US dollar. Tomorrow, if the Non Farm Payroll numbers come out as expected (200k ish, maybe less = pretty weak), then these opportunities will begin to solidify. 

 

The Opportunities

 

1. Earnings Revival

This speaks to the overall market for larger multinational companies like those in the Dow Jones Industrial Average who could see earnings surprises associated with more favorable currency exchange from foreign revenues. We would not expect a broad market rally higher until we saw an earnings revival. For now, earnings growth is down and falling and we need to respect that reality. But if the US economy can avoid a recession and if the US dollar trend remains lower, earnings could see a nice boost and all of this unpleasant market action will just look like a garden variety bear market (15-20% decline) within a longer term uptrend. This is, and has been, our long view expectation for several years. We believe this is a “Transition” market associated with a mid cycle economic pause within a much larger economic growth cycle. Wow, what a mouthful.

 

2. Energy/ Materials/ Industrials/ Commodities/ Metals and Gold/ Internationals

These sectors are the home to some of the best values out there. They have been pounded into the dirt for the last three years trading a 10 and 12 year price lows. We have all heard of the pain. But a falling dollar provides the right macro backdrop for these companies to get up and run higher. I am probably the least confident in a lasting rally from the oil and gas companies but they are certainly seeing some very nice gains suddenly. Oversold industrials and materials companies are probably the most compelling of the groups based on current dividends and valuations. They are just so darn cheap! Last week I also offered a potential investment allocation for internationals, which present some compelling value for investors right now. Again, the falling US dollar would be boost to returns for US investors. Even gold and gold miners are getting a tremendous lift now – up another 6% today. In the short term miners and gold bullion are overbought so buyers should wait for a pullback.

 

3. High Yield Bonds - Corporate and Emerging Market

I have mentioned this for weeks but there is a buy coming in the high yield bond market. Yield spreads are now attractive again and price trends are getting close to confirming a new buy signal. Nothing yet, but getting close. Emerging market bonds actually did trip our short term buy signal on Friday and we took a small position in our Blended Asset and Income strategies. As a quick reminder, High yield bonds have never lost money on a total return basis for two consecutive years. Last year, they lost almost 8% and are down another 3% YTD. 2016 should be good for this sector.

 

4. Dividend Payers

Dividend paying stocks tend to get hurt when rates are rising as they have been since February of last year. Now that the US economy is getting weaker, bond prices have moved up, rates have fallen and we now have a better backdrop to look for dividend payers. Again, many of the best names from a value perspective are in the industrials and materials sectors but also utilities and select consumer staples. Energy company dividends are suspect and being cut daily so again; we’re not going there. Three of the best dividend paying ETFs with the right mix of internal holdings for this market are HDV, DVY and SDY. We own the first two in several of our strategies. Both are nearly positive on the year, strongly outperforming the broad US stock indices and paying almost 4% annual dividends.

 

5. Value over Growth

This has been another topic of discussion in the last couple months but here again we have the right backdrop for a strong surge in the value side of the market at the expense of Growth. That transition has not happened yet but we’re seeing some early indications of a rotation in play. Make a list of your favorite Value mutual fund managers and keep them on deck.

 

Again, all of these opportunities really need the backdrop of a falling or even flat US dollar to move sustainably higher in the weeks and months to come. If this is just a correction in the US dollar and the uptrend reasserts itself, these same groups will fall out of favor again. It’s sort of strange to talk about opportunities on the back of a weaker US economy but that the enormous disconnect between Wall Street and Main Street. Some of the very best moments to be a buyer of stocks are just as the economy approaches a recessionary state.

 

Stay tuned

 

Sam Jones