Janet Yellen and the Federal Reserve must be terrified of saying the wrong thing. So much so in fact, that they continue to tell the markets exactly what they want to hear giving investors every reason to continue pumping money into stocks and bonds. Indeed, last week the market got a breath of new life from Federal Reserve commentary suggesting that they will not begin raising rates any time soon. Our best guess is still in the Fall (November) as it has been since the beginning of 2015. While we can almost hear an audible sigh of relief, the only thing that has really changed is the direction of the US dollar.
Highlights from Last Week
I Posted These Bullet Points Last Week – And Nothing Has Changed
The Big Picture for Stocks
- * Many “stock market” indices peaked last July
- * But there are still lots of things to own that are making new highs
- * 2015 is already a year that should benefit tactical/ active management styles
- * The bull market is still intact but adjusting to the prospect of higher interest rates.
- * It is too early to get really defensive but selection is critical now.
Stock Market is STILL Range Bound
For all the frenzied headlines in the last week, it’s important to see what is and isn’t really happening in the US stock market. What is happening is that small caps continue to push out to new highs as they have been since mid February. We are also seeing the same leadership in place, notably growth sectors, cyclical sectors and healthcare (including biotech and pharma). Again, this is nothing new and the strength in these areas continues today. But we should also recognize that despite the Fed’s breathing some new life into the credit markets, the S&P 500, the NYSE index and the Dow Jones World Stock indices are still range bound, meaning trading below a previous peak. Only small caps, and very marginally, the Nasdaq Composite have pushed out to new highs, much of which has to do with the strength of the US dollar since last summer. The Nasdaq Composite tends to track small caps as the index is broader than something like the Dow Jones Industrial Average, which has only 30 stocks. I will not be surprised if the US stock market does indeed make a new high soon but thus far, this simply hasn’t happened. Returns for the S&P 500 on a YTD basis have been +3% to – 3% and we are simply approaching the top of the “range” with today’s move. Selection is still key to making solid risk adjusted returns and getting more so as times goes on.
Financials Participating Again
Thankfully part of the surge in buying enthusiasm last week came from the financial sector which still represents one of the largest cap weighted roles in the US stock market. When financials are running, the primary trend for the US markets tends be up as well. I find this constructive and provides more evidence that the uptrend has further to run in the short term.
Probabilities Still Favorable
Bespoke Investment Group did some nice work this week on historical returns for everything from years ending in “5”, 3rd year of the Election Cycle and the current price pattern for the US stock market. On all three gages, it seems the odds are largely in our favor for another healthy stock market year. Years ending in “5” have an average return of +13% for instance. The 3rd year of the Election cycle also has a high probability average return of +13% and the current price pattern for stock in 2015 closely matches the pattern of several other stock market years which have yielded an average return of nearly +8% in the past. Of course, the past never repeats but the stats still show promise for the stock market in 2015. Now, I would not forgive myself if I did not mention two other things here. First, the US stock market has NEVER completed six consecutive years of higher prices. 2015 is potentially the sixth year of this bull market. Second, the market loves to disappoint investor expectations. If everyone is expecting yet another 8-13% year in stocks, the market will find a way to surprise us all.
Europe, Asia and Far East (EAFE)
Europe is looking better every week now, perhaps even better than the US in terms of valuations, growth rates, newly supportive QE from the European Central Bank and potential jettison of Greece from the Euro. Greece’s demands against Germany for WWII reparations in the form of current debt forgiveness are …… sad, pathetic, etc. Meanwhile, the Shanghai Composite has just made a new recovery high with nothing but blue ski between here and the highs set in the year 2007. I think China is back in gear. Finally, the strength in the Japanese market has been notable since last year. Yes, I see the impact of the declining Yen but we certainly didn’t seem to care about our stock market rising while the US dollar was in a death spiral either did we? Conveniently, we have a very nice index, which can be bought 100 ways through any inexpensive ETF call the EAFE index that stands for Europe, Asia and the Far East. Last week, we bought IEFA in several portfolios following the new leadership and replacing the emerging market positions we sold in late February. I do like the theme of expanding our international exposure but we’re trying to do so delicately considering the strength in the US dollar, which acts like a headwind. After a performance disaster in 2013, the EAFE looks much healthier and has been outperforming the US market since early January.
US Dollar Uptrend Stalling
This is perhaps one of the most striking changes in the last couple weeks. The US dollar has been in a frighteningly strong uptrend since July of 2014 creating numerous “dislocations” in the market. You might remember when the Swiss lifted the cap on the Swiss Franc causing their currency and markets to plummet sending several currency trading operations and hedge funds into bankruptcy. They simply could not artificially control their currency any more in the face of the strength in the US dollar and they paid the consequence for meddling with market forces in the first place. The rising US dollar has also been hard on companies with larger portions of their revenue generated overseas as they lost big repatriating their revenues back to the US. Small caps, which tend to be more domestically oriented, don’t have that issue, thus their recent relative strength to large caps. And who doesn’t know about the carnage in commodities and the energy complex both of which are directly negatively impacted by a rising US dollar.
Now, it seems the US dollar has moved too far too fast and the Federal Reserve has put their rate hike cycle off for a while giving US dollar investors a reason for pause. I do NOT believe the uptrend in the US dollar is over by any means but we should expect the currency to take a break from the near parabolic growth rate of the last 8 months at a minimum starting now. For investors this creates a huge opportunity. Now, we can consider adding back in some energy, energy service, metals, gold, silver and commodities positions if so desired. The buying opportunity is right now as prices are sitting almost at the lows of the year and of the last 5 years. Valuations are obviously incredibly attractive after 40-60% declines but remember this is just a place to grab a small toehold if you want it. We are not loading up by any means as we still expect higher highs from the US dollar over time. This is simply the first logical opportunity to take even a small position in the hard asset world as a nice diversifier to any investment portfolio.
Have a great week!
Sam Jones
