New Highs for the markets last week and a major shift in leadership to go with it. This appears to be the rotation into late cycle (Stage III) leadership we have been waiting for and its typically good time for smart investors who know where to go.
Revisiting Our Predictions
Last October at our annual client dinner, one of the major themes we discussed was the current state of the aging bull market in stocks. Most had that expected sense of dread after nearly six years of gains wondering when (in 2015), it would all come crashing down? Hopefully, we did a good job of instilling a little shot of confidence suggesting this bull had further to run. These were the bullet points behind our reasoning:
- * Confidence in the economy and the markets is largely neutral and bull markets rarely, if ever, end without a sense of total euphoria.
- * Valuations are high but not extreme yet. Expecting deeper corrections within an ongoing bull market from these levels.
- * Cash is plentiful both in household and corporate balance sheets and acts like fuel for higher prices, spending and corporate mergers.
- * The economy is recovering and now getting STRONGER.
- * Markets do not run into trouble until rates are above 5% on the 10 year Treasury. We are no where near that level.
- * Healthy new fund flows into stocks are barely 18 months old, most money has gone into bonds throughout this bull market in stocks!
- * Not 1 of our 6 primary trend indicators is giving us a warning of a bear market ahead (yet). Recession risk is not on the radar either.
Our thesis is that the market will experience corrections, normal bull market corrections, but they should be used as opportunities to adjust exposure slightly and upgrade positions as necessary. A normal correction would be 8-10%; under the circumstances, I would even accept 12-15% as a “normal” correction. So far, the markets cannot seem to pullback more than 5% before buyers come swarming in again. We suggested in our 2015 predictions that volatility would be much higher and it has been but that investors should not confuse periodic volatility with risk of permanent loss. Volatility we tolerate and risk we avoid!
We also suggested that investors be on the look out for a move into a Stage III market cycle, which appears to be happening now without much guesswork. Stage III is a very positive environment for investors but one in which selectivity matters a lot. There are clear winners and losers among sectors so let’s look at the new leadership established since the beginning of February.
Stage III
Martin Pring, the guru of market cycle work and the inspiration behind the name of our firm with his book, “The All Season Investor”, establishes a Stage III environment generically as good for stocks and commodities, bad for bonds. That seems to be the case now at least starting this month. Treasury bonds are down nearly -7.5% and I think this is just the beginning of the pain. Commodities are working hard to find a bottom including energy, oil and gas stocks. I still feel like it’s early for the energy sector but materials, gold, silver, food, timber and other commodities are starting to move up strongly from a very deep discount level. I’ve heard so much noise in the financial media about the end of the commodity super cycle and massive global deflation that my inner contrarian is starting to look seriously at taking a pure commodity position again after nearly 5 years of little to no exposure. I’ll let this one prove it a little more but I’m watching. Stocks are still in the limelight and worthy of a full position, perhaps overweight still as we have been since 2012. But the leadership among stocks just took a sharp turn in a new direction.
Late cycle leadership found in Stage III is typically good to technology, materials, industrials, non-interest sensitive consumer groups, energy, and financials. Healthcare can do ok but not typically better than the averages. On the weaker side, we often see consumer staples, utilities and defensive names lag behind. Growth is still dominant over value and mid caps seem to be in the sweet spot but there isn’t much difference among the difference size categories. The last two weeks has really been a case study in a Stage III environment and we have made a lot of changes to follow the new leadership. Please excuse our dust!
Internationals continue to lead the US market, slightly. Here we have to be a bit careful while the US dollar is still in a new long-term uptrend but there are an increasing number of options if one is inclined to add some diversification. I have weeded through the list of countries filtering out those with weak economics, weak fundamentals or heavy dependence on oil and gas exports as well as those that are just way overbought in terms of their stock markets. These are the countries and regions that I still find attractive and those that I’m watching for a potential buy
Attractive Now
Turkey
Pacific Ex Japan
China
India
Europe minus the PIGS
On the Buy Watch list (waiting for oil to find a sustainable low)
Russia
Brazil
Canada
Still, we’re limiting our total exposure to internationals to 10-12% per strategy.
Chugging our Savings
As a final note, I thought it was interesting and funny what good Americans are doing with all of their savings at the pump in the last month. According to Bespoke, Gasoline revenues YTD are down nearly -23%. Last week, I filled my empty Suburban and it cost less than $40. Typically, it would cost $90-$100. I don’t fill up very often but I did notice. What is didn’t do is what many Americans seem to be doing – hit the bar! The percent of total retail sales going to bars and restaurants shot up to 11.3% so far in 2015. I chuckled when I saw this chart.
When times are tough (2008), the tough hit the bar. When times are good, the tough apparently also hit the bar. We should all be in the bar and restaurant biz eh? I guess eating and drinking is a consumer sector but I don’t think that’s what the media had in mind.
Have a great week and would someone in the east coast please send us some snow. This is nuts. I’m afraid people will start calling snow “Powda” if this keeps up.
Cheers
Sam Jones
