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Grinding Through September


             September is living up to its reputation as a tough month for investors.  While the S&P 500 and other “benchmark” indices are still trading within 2% of all time highs, the real damage to the markets has been far more severe over the last couple months.  Recognizing when an investment is forming a larger top versus a minor correction is key now.  This is a great moment to cut out weaker positions and upgrade.  I’ll give you some options to consider.

 

Damage Report

 

            Consider this.  According to Bespoke Investment Group, the average large cap stock is now down -7.5% from its 52 week high, Mid caps are down -11.1%, small caps are down -17.3% (almost a bear market) and the average stock in the broader S&P 1500 index is down -12.4%.  52 week highs for each of these market segments occurred in different times this year with some setting in March, others in July and still others as recent as September 1st.  Here’s what the damage report looks like from a sector perspective (Bespoke Investment Group)

 

 

 

Pretty ugly really remembering that these are averages as well.  We’ve given up a couple percentage points in our own equity strategies over the course of the summer and early fall but all are well within 2% of all time highs – nothing close to the damage above. 

 

Nothing to Fear but Fear Itself

 

            Since the beginning of September, fear of a change in Fed. Policy seems to be dominating investor’s minds – and trading choices.  Granted, the markets are very efficient at processing information and forecasting economic events months in advance of reality.  Is the Federal Reserve going to surprise everyone with a change in their plan regarding their monetary policy on Wednesday?  Highly unlikely.  But still, the trends being forecast by the markets are as real as the pending change of seasons.  The Federal Reserve is withdrawing from the massive support for the US economy and doing so with a well-projected plan.  Without a doubt, at some point, in the next 6-12 months, the Fed is going to start raising short term interest rates.  At some point in the next 4-6 months, the Fed will end its bond purchase program completely.  At some point in the near future, market driven interest rates and borrowing costs will begin to rise from near zero levels.  I have labeled 2014 as a “Transition Year” for the market or a period where the US market and economy take their first steps without assistance from the Fed.  We are going to get out of the “recovery” room and start walking on our own as economic data now confirms.  Some investors think the US economy cannot take those steps, is not ready, will never be ready.  I am not one of those investors.  So the Transition Year is happening, that’s all.  Fear is just part of investing and a natural feeling for those of us who have been at for 20+ years.  For those attending the upcoming annual meeting on October 9th, you will see why rising rates (to a degree) are not to be feared and often coincide with very nice price gains in stocks.  Nevertheless, selection is becoming more and more important as we would expect during this phase of an aging bull market.

 

Selection is Key

 

            Unlike 2013, this year has not been one in which all ships rise with the tide.  The US dollar has embarked on a new long-term uptrend driven higher by RELATIVE currency value changes in the Yen and the Euro.  Interest rates across the spectrum of maturities, will soon follow higher as mild inflation and global currency exchange rates begin to have an impact.  So what is an investor to do?  Hide?  Sell all?  Hardly.  As I have said many times this year, we want to begin cutting out positions that are going to be adversely impacted by the developing late stage environment.

 

Last week’s market action gave us a clear path forward.  These are the areas of the market that got trashed and should serve as areas to consider upgrading in the coming days/weeks.  Most of these are now way oversold so should be good for at least a bounce this week or next.  Consider selling on the bounce?

 

Real Estate and REITS – Ouch!  Down 5% in 5 days

Consumer Discretionary – already underperforming YTD, will get worse

Precious Metals – Still heading south while trying to find a bottom

Energy – Can’t stop losing money.  Now looks like a long term top

Utilities – Terrible business models and will suffer when rates rise

Commodities – Bombs away, now down 7.5% YTD, might be close to a bottom.

Treasury Bonds – Wouldn’t own them for the next 3-5 years

Corporate bonds – Will be back on the buy list but on a sell now

Russia – No one likes a bully – avoid for now

Europe – Recessionary (again)- shrinking share of global GDP 

 

These are areas of the market that should continue to lead the market higher during our Transition Year, possibly beyond.

 

Technology – Buy Dips – we’re getting one now, be careful with internet stocks

Financials – Still a great value

Healthcare – Aging Baby Boomer demand trumps all, be careful with biotech stocks

Emerging Markets – If they hold right here, this could be a great entry point

China and India – Same

Japan – Breakout is still holding, beneficiary of falling Yen

 

Land Ho!

 

            While we’re still out at sea, taking on a little water in the 3rd quarter storm, there is still the very distinct possibility of a robust 4th quarter ahead.  Remember, the next three quarters are statistically the most productive of the entire 4 year presidential cycle averaging almost 8% each quarter.  That period begins in just two weeks.  Nothing is guaranteed mind you and the nearly 30% market gain in 2013 was also an event that is completely out of cycle.  So all things considered, we want not to give up on stocks just yet.  I think the smart money will use the next two weeks as an opportunity to sell selectively, raise some cash and watch relative strength closely for an indication of what things will lead strongly in the final quarter of the year.  If we see indications of a healthy new uptrend with robust buying, we’ll be fully invested again.  We are following that plan in all strategies and hope to finish 2014 in fine shape.

 

That’s it for this week – don’t forget to pay your quarterly estimated taxes today

 

Cheers

 

Sam Jones