Yesterday I wrote that the recovery that follows a sharp stock market decline is an important time to look for changes in the kinds of stocks that investors are eager to buy and the ones they’re happy to dump overboard.  I’m not sure why take place at these market inflection points, but the very often do.

Step one in trying to detect new patterns is for each of us to examine our own holding to see what’s happening with them.  We’re not just looking for under performance/outperformance during the downdraft.  We’re basically looking for two kinds of outliers:  stocks that underperformed on the downside and are continuing to underperform (bad!); and for stocks that outperformed on the way down and that are continuing to outperfrom now (very good!).

Step two is to widen our search to try to get a feel for what the overall market is thinking.  The way of doing this that I find most useful is to try to imagine the general economic situation the world is in and what kinds of stocks should be winners/losers if my picture is right.  Then I look at the stocks themselves to see whether their price movements confirm my thoughts or not.  Then I adjust if needed and repeat.

The most difficult situation is one where I’m 100% convinced I’m right but the stocks say otherwise.  This is rarely the case, in my experience.  At least someone has already picked up on a major investment theme before me.  But that’s okay.  A trend may last for years.  If I’ve missed the first three months it’s not a big deal.  Besides, being the only one in the restaurant has a kind of eerie feel to it.  If I’m thoroughly convinced I’m right, I’ll probably take a small position and prepare myself to add more quickly as other diners come through the door.

what I’m looking for now

The world is still in a slow recovery from the Great Recession.  The US is doing fine, given dysfunction in Washington.  China has structural change issues that have it growing at a “mere” 6% – 7% or so.  On the other hand, the warts in Abenomics in Japan are showing themselves and the EU is starting to look a lot like Japan of the 1990s.

Four big macro changes over the past, say, six months:

–China has been much more persistent than I had thought possible in trying to steer its economy away from low value-added export-oriented manufacturing toward higher-end businesses aimed at a domestic audience.  This changes the composition of growth, but is good, in my opinion.

–The EU is flirting with recession again.  The biggest culprit is France.  This is bad.

–Energy prices are falling–a lot.  This is bad for energy producers, great for everyone else.

–I had expected world growth developments to express themselves mostly (exclusively?) through changes in stock prices, with the US going up and the rest going sideways.  Instead, the principal expression has been through changes in currency values. This makes a difference.  A higher dollar slows economic gains in the US in much the way an increase in interest rates would; the fall in the euro acts as a (desperately needed) stimulus for the EU.

So, I expect…

1.  Slow GDP growth means secular growth stocks will do well, cyclical value stocks (much) less so.  Long Millennial/short Baby Boom ideas may be the best.

2.  Companies with costs in euros or yen but revenues in dollars stand to be big winners from recent currency moves.  So too companies with assets in the US.  Assets or earnings in the EU or Japan are now worth less in dollars than they were earlier in the year.

3.  The energy situation has a lot of moving parts (more tomorrow).  The clear winners are energy users.  The clear losers are the oil-producing countries where the deposits are controlled by national oil companies (think: Latin America, Africa).

Once I publish this, I’m going back to see if the markets are running with these ideas or not.