Notable Change in the Market Character
Things are starting to change. The light, colors, temperature and the financial markets. There are seasons to everything. Yesterday, we witnessed a notable change in the character of the markets that has us rotating in and out of different asset classes, sectors and holding. This will be a quick update with the intention of showing you how our system responds to changes in risk, opportunity and leadership as dictated by market trends.
The Most Interesting Thing I Read This Week
Forbes – Why American Companies Choose China Over Everyone Else – 9/3/2019
This is not an opinion piece. It is just a clear overview of why so many US based companies have chosen to work with China over all other developing countries. What they don’t say explicitly, but imply, is that they are also choosing China over the US as a place to manufacture their goods. The key driver of overseas manufacturing is price (cost) of course and it’s going to take a lot more than Trump “ordering all US companies” to bring their manufacturing operations home. Crazy talk. Anyway, just a little quiet truth during this political and physical hurricane season.
Change in Market Character
Bond/ Stock ratio at an Extreme
Practically every measure of the relationship between bonds and stocks, points to the same level of extremes. For instance, bonds yields are now below the dividend yield of the S&P 500. That’s happened a few times in history but not many. Each time, we have seen stocks rise dramatically and bond prices fall sometimes dramatically. Yesterday, we saw stocks finally break up and out from a period of congestion and high volatility right around the long-term price average. Meanwhile, bonds of all sorts, saw real selling pressure from a place and time that can only be described as extremely overbought. Yesterday, we reduced our bond exposure and added to our stock exposure. This looks like a good foundation from which stocks could start a new uptrend. I couldn’t tell you why or justify the move from a fundamental or economic perspective. Optically, all things seem to be pointing to recession in 2020. But herein lies the greatest challenge for investors over time. We all need to feel like price action follows a story that we have accepted. We want to see things happen in an orderly way. When we all begin to accept the story that recession is coming, then we expect price action to follow accordingly (stocks fall, and bonds rise). Well, the markets have a crafty way of moving directly against consensus opinion, often just as you have finally decided to embrace the common logic. This may be one of those times.
Sector Rotation Out of Defensives
Consistent with the stock / bond rotation, we also saw a significant change in leadership yesterday. Financials, industrials, technology and growth jumped higher as investor rotated out of defensive sectors like utilities, healthcare and consumer staples. In the last week, we have followed the new leadership moving back into banks, financials, adding to semiconductors and industrial stocks. It is too early to say with confidence that this rotation is sustainable so we’re moving slowly and acting only as price patterns and evidence persists. We expect to see defensives underperforming from here. It always feels safer to buy something that has recently pushed out to new highs. But investors should be looking “down” for opportunities. Find things that have pulled back in price to a rising long term moving average. Find things that still have attractive valuations and are seeing healthy buying enthusiasm now from a price low. Be careful about reaching for high dividend payers here or areas of the market that feel safe. Safe can bite you when the market is rotating back toward the growth side of the market.
Internationals versus the US dollar
The US dollar has been moving steadily higher over the last month as fear and headlines have driven money into bonds and other safety investment (US dollar, gold, etc). Consistent with the change of character in other areas, the US dollar looks like it just made an intermediate term peak. A falling US dollar should be good for internationals, especially emerging markets. Investors looking to add back to equity exposure might choose a balance between US and international holdings here as we now have the tailwind of a falling (or consolidating) US dollar.
Seasonality is Still Unfavorable
I’ll finish with a quick word of caution. Seasonally, this is not the best time to be stepping up to buy stocks. September and October have seen some of the worst market wipeouts in history. I don’t know why but clearly, we are still in the time zone of buyer beware. Historically, investors have been better served to wait until Halloween or beyond before stepping up aggressively. Based on what I’m seeing, it would seem that investors could use the next 30-60 days to PATIENTLY wait for select buying opportunities and let the market action prove itself to be sustainable. I do have some PTSD from October of 2008, when we saw a similar, brief, rotation back toward cyclicals and non defensive sectors in equities. Obviously, that was not a time to buy stocks. Prices fell 40% until March of 2009! Those who fail to heed the lessons of the past are doomed to repeat them!
Stay tuned and have a great weekend