Well I can’t say that I’m that surprised with the start of the year beginning negative for stocks – now down a bit over 1% in the first three trading days. The end of 2013 was just a bit too good and we should expect some profit taking early in the new year, right. Still, we don’t know where this mild correction will end and none are very interested in giving up what was made last year. How much pain should we tolerate before becoming more defensive? How much should we be willing to lose just to stick with the primary uptrend? GULP!
Market Support – GULP
Of course, the market is just an observable creature by which we can assess overall conditions. It does not have to represent our investments. For those of us who are not indexers, we only measure support and resistance on “the market” to determine risk and thereby our total exposure to stocks. For others, the market IS their investment and thus support lines might have a more salient meaning. From my seat, we should all be willing to tolerate any profit taking in “the market” for at least another 3% loss which would bring us down to the shortest of the most meaningful moving averages (the 50 day SMA). On the S&P 500, we’re talking about 1789. However, a basic look at the S&P 500 chart of the last 7 months shows the S&P 500 index has violated the 50 day moving average three times before quickly rebounding higher back into the primary uptrend. So, with that knowledge, I’m going to extend the GULP factor by another 1% marking support on the S&P 500 at the lows of December (1772). A strong move below this level on rising selling pressure would change the technical picture rather dramatically and put us on target for a deeper correction down to the next level of support around 1684 on the S&P 500. That’s a 10% correction from the high set on 12/31 and regular readers know I expect more than one of these in 2014.
Preference for GARP
It’s really hard to identify leadership with only three market sessions in the new year but I’m going to tell you what I think is happening in terms of investors’ preferences based solely on winners and losers so far. GARP stands for Growth At a Reasonable Price and this seems to be the sweet spot for new purchases thus far. The market is still hunting for growth but given the whopper year in 2013, investors are rightly a little critical of paying any price for it. The talking heads are saying that the valuation for “the Market” is below the average of the last 15 years. Now that does not provide a lot of comfort for me. Think about all the averages inherent to that statement. We have “the market” average, which is made up of VERY overbought things and some very oversold things. Then we have the 15-year average and it has been a wild 15 years for stocks with extreme highs (year 2000) and extreme lows (2008) in valuations. Averages aren’t worth much when the range of statistical significance is this wide. What we can recognize is that 2014 is going to be a stock pickers’ year, meaning one can do very well if one has the tools and systems to invest in stocks selling at real discounts to growth. We have been busy in the last couple weeks making upgrades to current positions along those lines.
Specifically, we are selling positions that have falling or declining earnings per share growth rates (3 year trends) with unsupportive price to earnings (PE) ratios. In many cases, this means selling a position that no longer carries double digit earnings growth. Now that sounds like an unreasonably high bar but there are plenty of options out there with solid double digit earnings growth selling at a P/E of 15 or less. These are GARP stocks and we are picking them up now.
Beyond individual names, there are growth-oriented sectors, which are generally cyclical in nature, also getting some investor attention early this year. Some did OK last year, but many reallyunderperformed the broad US stock market making them potentially good candidates for 2014 investments. Highlights are banks, financials, real estate and select technology. Oddly, many of these are obviously interest sensitive sectors. While the Fed is now openly discussing the end of QE and bond buying programs, the market seems to think that low interest rates are here to stay. Or put another way, it seems that the bond market may have fully discounted the mild reduction in Federal stimulus that investors expect.
Gold and Silver are raging higher after the 2013 massacre but the conditions are just not right for Gold or Silver so I’m not really considering either.
Income Models Back in Gear
Our Freeway High Income and Retirement Income (previously called “High Income”) programs hardly made a return in 2013. Both are bond strategies and bonds did poorly across the board. Most of the year we were playing defense or sitting in cash as dictated by our discipline. Well now, of course, both models are leading the charge in 2014 as our best performers at least for last week. I am not surprised in the least. Often our worst performing strategies leap to the top of the leadership board on the next cycle. Both strategies are almost fully invested in high yield bond funds and hybrid securities including floating rate funds, high yield muni bond funds, preferred securities,REITs and corporate bonds.
I’ll certainly have a better feel for leadership in the next couple weeks so I’ll keep this short for now. There will be no Red Sky Report next week as I will be busy compiling the year end Change of Seasons report with detailed insights into our various strategies.
Have a great week and Happy New Year to everyone!