yesterday’s S&P 500 stock price action

Yesterday may have marked an inflection point in the US stock market.  Today’s potential follow through, if it happens, will give us a better idea.

Domestically, Mr. Trump appears to be moving on from pressing his social program to tax reform–and, maybe, infrastructure spending, both of which are issues of potentially great positive economic significance.  At the same time, results of the first round of the French presidential election (which pollsters got right, for once) seem to suggest the threat that France might leave the euro, thereby reducing the fabric of the EU to tatters, is diminishing.

yesterday’s S&P 500

How did Wall Street react to this news?  The sector breakout of yesterday’s returns, according to Google Finance, are as follows:

Staples          +1.7%

Finance          +1.6%

Industrials          +1.4%

IT          +1.4%

Materials          +1.2%

Healthcare          +1.1%

S&P 500          +1.1%

Energy          +0.8%

Consumer discretionary          +0.7%

Utilities          +0.6%

Telecom          +0.3%.

winners

Staples led the pack, presumably because this sector has the greatest exposure to Europe–and a rising euro.  Financials advanced significantly also, on the idea that stronger economic growth will lead to rising interest rates, a situation that benefits banks.

Industrials and Materials perked up as well.  Again, these are sectors that benefit from accelerating economic growth.

losers

Energy marches to the beat of its own drummer. The rest are consistent with the story behind the winning sectors, either defensives or beneficiaries of moderate (that is, not rip-roaring) economic performance.

My guess is that this pattern may continue for a while yet.  Personally, I’m most comfortable participating through Financials and IT.

 

 

 

 

the Trump rally and its aftermath (so far)

the Trump rally

From the surprise election of Donald Trump as president through late December 2016, the S&P 500 rose by 7.3%.  What was, to my mind, much more impressive, though less remarked on, was the 14% gain of the US$ vs the ¥ over that period and its 7% rise against the €.

the aftermath

Since the beginning of 2017, the S&P 500 has tacked on another +4.9%.  However, as the charts on my Keeping Score page show, Trump-related sectors (Materials, Industrials, Financials, Energy) have lagged badly.  The dollar has reversed course as well, losing about half its late-2016 gains against both the yen and euro.

How so?

Where to from here?

the S&P

The happy picture of late 2016 was that having one party control both Congress and the administration, and with a maverick president unwilling to tolerate government dysfunction, gridlock in Washington would end.  Tax reform and infrastructure spending would top the agenda.

The reality so far, however, is that discord within the Republican Party plus the President’s surprisingly limited grasp of the relevant economic and political issues have resulted in continuing inaction.  The latest pothole is Mr. Trump’s refusal to release his tax returns–that would reveal what he personally has to gain from the tax changes he is proposing.

On the other hand, disappointment about the potential for US profit advances generated by constructive fiscal policy has been offset by surprisingly strong growth indications from Continental Europe and, to a lesser extent, from China.

This is why equity investors in the US have shifted their interest away from Trump stocks and toward multinationals, world-leading tech stocks and beneficiaries of demographic change.

the dollar

The case for dollar strength has been based on the idea that new fiscal stimulus emanating from Washington would allow the Fed to raise interest rates at a faster clip this year than previously anticipated.  Washington’s continuing ineptness, however, is giving fixed income and currency investors second thoughts.  Hence, the dollar’s reversal of form.

tactics

Absent a reversal of form in Washington that permits substantial corporate tax reform, it’s hard for me to argue that the S&P is going up.  Yes, we probably get some support from a slower interest rate increase program by the Fed, as well as from continuing grass-roots political action that threatens recalcitrant legislators with replacement in the next election.  The dollar probably slides a bit, as well–a plus for the 50% or so of S&P earnings sourced abroad.  But sideways is both the most likely and the best I think ws can hope for.  Secular growth themes probably continue to predominate, with beneficiaries of fiscal stimulation lagging.

Having written that, I still think shale oil is interesting   …and the contrarian in me says that at some point there will be a valuation case for things like shipping and basic materials.  On the latter, I don’t think there’s any need to do more than nibble right now, though.

 

 

where’s the tax selling?

Pretty much all mutual funds and ETFs in the US have tax years that end on October 31st.  They are required by law to distribute virtually all the dividend/interest income and realized capital gains collected during the fiscal year to shareholders by calendar yearend (so that the IRS can collect income tax from holders).

Invariably, funds adjust the size of these distributions during September – October.  Whether this means making them larger or smaller, it involves selling.  This means a seasonal market correction between September 1st and October 15th.  The only exception I’ve seen in over thirty years has been in times directly following a major market selloff like that in 2000 or in 2008-09, when funds are working off massive realized losses–and have no taxable income to distribute.

Last year, for example, the selloff in the S&P was about 7.5% and went from mid-August through late September.  2014’s was 6%+ and lasted from September 19th through October 17th.

This year September has delivered about a 1% loss so far, which would be an extremely small seasonal dip.

 

Where’s the selling?  I don’t know.  Maybe the lack of downward market pressure comes from the fact that the S&P is flat during the current fiscal year.  In any event, if selling doesn’t emerge in the next, say, week, it’s unlikely to develop.

If it doesn’t, we’ll have missed an annual buying opportunity and will have to press ahead with annual portfolio adjustment plans without this advantage.

Odd.

 

August-October in mutual fund/ETF-land

 August has traditionally been a slow month in financial markets, for two reasons:

–Europe, including European factories and stock markets, pretty much closes up for the month and everyone goes on vacation

–on this side of the Atlantic, high-level Wall Streeters head for the Hamptons, leaving behind cellphone numbers and assistants who have less authority to make independent decisions–and who certainly don’t execute changes in strategy.

Yes, in today’s world the EU is much less significant than it used to be and Industrials as a group are a mere shadow of their former selves.  But the vacation effect is still a powerful soporific.

 

In September, mutual fund/ETF minds turn toward the end of the fiscal year, which occurs on Halloween.

Mutual funds/ETFs are special-purpose corporations.  Their activities are restricted to investing; they’re required to distribute to shareholders as dividends each year virtually all of the profits they recognize.  (In return for these limitations, they’re exempt from corporate income tax on their gains.)

About thirty years ago, with government encouragement, the industry moved up the end of its fiscal year from December to October.  This gave funds two months post-yearend to put their books in order and get checks in the mail in December, so the IRS could collect income tax from holders on those distributions in the current year.

Because of this, fund/ETF preparation for the October 31st yearend typically begins in early or mid-September.  It invariably involves selling.

How so?

For reasons that completely escape me, mutual fund holders like to receive distributions. They regard it as a mark of success.  And they seem to like a payout of around 2% -3% of asset value.

For most of the year, the tax consequences of their decisions are not in the forefront of portfolio managers’ minds (strong industry belief is that taxes are tail that shouldn’t be allowed to wag the portfolio dog).  As a result, distribution levels most often require fine-tuning.  This means either selling to realize an additional gain, or selling to realize an additional loss.  Either way, it means selling.

At the same time, this occurs close enough to the end of the calendar year that PMs often use the opportunity to begin to make major portfolio revisions in anticipation of what they think will play out in the following calendar year.  This means more selling.

 

October often sees the beginning of a rally that lasts into December, as the fiscal yearend selling pressure abates.  Accountants play a role here, as well.  Every organization I’ve been in requests that PMs avoid trading, if possible, during the last two weeks of the fiscal year.  That’s to avoid the possibility that a trade has settlement problems and isn’t completed until the beginning of the following fiscal year.  PMs mostly play only lip service to requests like this, but it does ensure that purely tax-related selling is over by mid-month.

 

a(n important) footnote

Like any other corporation, if a mutual fund/ETF has net losses, it carries them forward for use in subsequent years.  Virtually every fund/ETF has been saddled for years with large tax loss carryforwards generated by large panic redemptions at the bottom of the market in 2008-09.  These had to be offset by realized gains before a distribution would be possible.

Last year was the first time that enough funds/ETFs had used up losses and were able to make distributions.  During the second half of last September, the S&P 500 fell by about 5%, before rallying from  early October through late November.