As one of our clients opined recently, “I knew I would need to buckle up a bit this year but didn’t expect I would need a 6 point harness!” Yes the widely expected higher market volatility is with us now. Losers are becoming more pronounced and worrisome while gainers have been limited and thin. Such is the nature of a market correction. You already know that I expect anything but an average 8% year as is the consensus among market gurus, so let’s look at the current state of investment opportunity and risk as it stands so far in 2015.
Growth and Income
For those like us who regularly measure risk and reward metrics among various asset classes, investment styles and strategies, you have a clear path to walk so far. This year, we are seeing the market showing strong and broad preference for all types of income oriented securities (interest or dividends) and some very focused, selective desire for growth. Virtually everything else is under selling pressure. 2013 and the early part of 2014 were just the opposite in terms of investor preferences so take note. For those who recognized the shift in July of 2014 associated with the long-term bottom in the US dollar, you have had to do very little to your portfolio thus far in 2015.
Here’s the list of INCOME bearing securities that continue to push out to new highs with very little selling pressure.
Long term Treasury bonds
Real Estate funds and REITS
Preferred Securities
Investment Grade Corporate bonds
Utilities
Municipal bond funds (high yield and intermediate term)
Select Dividend paying stocks – mostly in the consumer staples sectors
*We own great gobs of all of these except long-term Treasury bonds for our clients.
Here’s a list of the GROWTH sectors and securities also making new highs
Biotech
Notice the very short “list”
Now I’m painting a very bleak looking picture of the market based solely on new highs but that doesn’t tell the whole story. There are a number of things that are beginning to look like they want to form attractive bottoming patterns and others that are showing clear relative strength to the broad US stock market but are not yet in obvious up-trends. Among those showing relative strength, I think there are some short-term opportunities developing as considerations for upgrades or for new money looking to get invested.
SELECT Internationals
2014 was a tough year for internationals with the exception of China and India. Most were down on the year in the double digits. Oil dependent countries lost 30% or more. With the end of year, we looked at the all the country oriented fundamental research and found several countries to be a better value in terms of their stock market and with higher economic growth rates than the US. Specifically, these are developing Asia Pacific ex Japan, South Africa, Turkey and India. All others are either on par with the US or not as attractive as the US. Developing country ETFs and aggregate funds like emerging markets have also shown some very nice relative strength to the US stock market since the lows in December even while the US dollar continues to rage higher and commodities of all sorts make 10 and 15 year new lows. I’ve said this several times in the last 6 months but I find it very interesting that emerging markets and commodities have become non-correlated (are decoupling). This has been a long -standing positive relationship for many years, almost decades and it tells me that emerging markets are now stronger than most think or that commodities are perhaps artificially oversold now. Considering the relative growth prospects, fundamental strength and improving technical price patterns, we think there is a case to be made for cutting back a little exposure to the US market and re-engaging with select internationals (those mentioned above). Move slowly and mildly if you want to make this change. We have taken small entry level positions as of last week with proceeds from the sale of select US based index and sector funds. Beyond this select list of internationals, I would continue to steer clear of most overseas investments for 2015 (see discussion of US dollar below)
Energy
What? I know – energy companies have been in the doghouse in sync with the new uptrend in the US dollar since last July. They have fallen by nearly 50% in less than 5 months taking no prisoners. I saw Unleaded gas in Denver on Monday for $1.81. But looking at the short term it seems that energy funds and stocks are now working hard to find a low. Each down day in the stock market, we see energy stocks recover nicely into the close and sometime finish UP on the day. Even the Flintstones of energy companies (Exxon Mobile) is outperforming the S&P 500 since the last major market low on December 15th! Some big money is beginning to accumulate energy stocks. We are not (yet). Our discipline mandates positive price trends to justify a current investment and I see no positive price trends in the energy complex yet. From what I understand, imbalances between the NEW glut in supply and LONG standing decline in global demand for oil since the year 2001 are likely to continue well into 2016. But have energy prices fallen enough to price in those metrics? Maybe, but I’m doubtful we’ll see a real sustainable surge higher until the imbalance improves. Those arguing that falling oil represents the real truth of stagnant global growth are not looking at the facts. Oil demand has been falling for years in response to higher fuel efficiency standards, greater shifting of global economy toward service based industry as well as substitution effects coming from adoption of renewables. As I said last year, the power structure in the energy complex is shifting away from traditional fossil fuels and carbon based power at a deliberate and consistent rate annually (2-3%). Energy may be a developing investment opportunity but it might be better to stick with some of the more progressive energy companies with diversity in their product and servicing lines if you want to buy in. All in, I think there are better investment options than energy in 2015 but some stability in the energy complex might be a good thing for the market as a whole with the exception of the consumer groups.
Long US Dollar
This is a very strong trend in the market and one that is wildly oversubscribed by hedge funds and technical types. The US dollar has been raging higher since July creating the clear channel of winners and losers. We did a lot of research last year looking at past periods of US dollar strength. The returns by asset class and sectors then are identical to the trends we see today. A strong US dollar favors domestic issues, growth, cyclical sectors like consumer, bonds, real estate, utilities, health care and technology specifically semiconductors. These are the very things that continue to look great today. Now the trend in the US dollar is stretched to the upside in the short term but long term the up move has just barely begun and is likely to continue. If one wants to TRADE internationals or energy or commodities each time the US dollar falls back a bit, it could be worth the ride, but I would not expect much in the way of longer term trends in these areas as I mentioned above. What would it take for the US dollar to reverse its uptrend? It would take Europe becoming a stronger economic force than the US. It would take a massive recession in the US driving a complete reversal in US Federal reserve policy and a return to Quantitative Easing. I don’t see either of these events happening anytime in the next 2-3 years. Bet on a strong US dollar for a long-term trade and bet on the sectors that go along for the ride. Let’s not make this harder than it is.
That’s it for this week and next as I’ll be finishing the year-end Change of Seasons report where we outline in detail our investing principles, our process and our discipline for all to see. If you are a client, please take some time to read this upcoming report. It will answer many of your questions about how we manage your money and build confidence that our systems are truly built for “All Seasons”.
Happy New Year to everyone!
Sam Jones
