what about last Wednesday?

That’s the day the S&P 500 took a dramatic 2% plunge, with recent market leaders doing considerably worse than that, right after the index had reached a high of 2400.

Despite closing a hair’s breadth above the lows–normally a bad sign–the market reversed course on Thursday and has been steadily climbing since.  The prior leadership–globally-oriented secular growth areas like technology–has also reasserted itself.

My thoughts:

–generally speaking, the market is proceeding on a post-Trump rally/anti-Trump agenda course.  Emphasis is on companies with global reach rather than domestic focus, and secular change beneficiaries rather than winners from potential government action that have little other appeal

–while trying to figure out whether the market is expensive or cheap in absolute terms is extremely difficult–and acting on such thoughts is to be avoided whenever possible–the valuation of the S&P in general looks stretched to me.  Tech especially so.  This is especially true if corporate tax reform ends up being a non-starter.  My best guess is that the market flattens out rather than goes down.  But as I wrote a second or two ago absolute direction predictions are fraught with peril

–tech is up by 17.0% this year through last Friday, in a market that’s up 6.4%.  Over the past 12 months, tech is up by 35.2% vs. a gain of 16.8% for the S&P.  Rotation into second-line names appears to me to be under way, suggesting I’m not alone in my valuation concerns

–currency movements are important to note:  the € is up by about 10% this year against the $, other major currencies by about half that amount.  Why this is happening is less important, I think, than that it is–because it implies $-oriented investors will continue to favor global names

–the next move?  I think it will eventually be back into Trump-motivated issues.  For right now, though, it’s probably more important to identify and eliminate faltering tech names among our holdings (on the argument that if they can’t perform in the current environment, when will they?).  My biggest worry is that “eventually” may be a long time in coming.

 

 

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.

 

 

managing a stock portfolio in a flattish market

In many ways it’s easier to manage a portfolio in a market that has a clear trend, no matter whether it’s up or down.  That’s because there are standard rules for general portfolio structure for each.

an up market

The industry cliché is that it’s hard to keep ahead of a rising market.  I’ve never felt that way, even though the early stages of a bull market favor value investors, not growth investors like me.

The key is to keep a pro-cyclical orientation.  That means overweighting the most economically sensitive sectors, like Materials, Industrials, or IT and keeping away from less cyclical, or defensive, sectors like Utilities, Staples or Healthcare.

Smaller-cap stocks are typically better than their large-cap brethren.

A generous helping of foreign markets–emerging markets, in particular, also usually helps.

a down market

A downtrending market is certainly a lot less fun than an uptrending one.  (Almost) no one likes to lose money.  The rules for a bearish phase are just about the opposite for a bullish one.  But they’re just as clear-cut.

In a down market, stock investors try to make their portfolios look as much like local government bonds as possible.

That means large-cap holdings instead of small-cap; no foreign stocks, plus industries and sectors with as little sensitivity to the economic cycle as possible.

Overweight Utilites, Staples and Healthcare, and underweight Materials, Industrials, IT–and maybe even Consumer Discretionary.

Although it sounds a little silly once you have the benefit of hindsight, but I find the biggest difficulty in handling a down market is recognizing that you’re in one in the first place, and not in a particularly nasty upmarket correction.

Oddly enough, even bear markets have more up days than down ones.  But during the up days stocks barely move.  And the down days are brutal.

flat

Normally the stock market either wants to go up or to go down.  It’s seldom content to idle.

If short-term traders (include brokerage trading desks, some hedge funds and individual day traders in this camp) decide it’s unlikely that stocks will decline, they begin to buy.  When they determine there’s little possible upside, they begin to sell.  They only make money if stock prices are moving, so they try to make it so.  They have a lot of clout.

As a result, flattish markets–like the one I think we’re in now–are fragile things.

As far as I can see, traders think there’s little near-term upside for US stocks.  They judge that the price earnings multiple expansion that has been driving prices upward over the past year is just about spent.  On the other hand, the Fed is continuing to keep the money spigot wide open.  Yes, the spigot might be turned back a notch next month, but there’s absolutely no discussion of the possibility that any of the extra money that’s been pumped into the economy over the past several years will be withdrawn.  We’re just slowing the  rate at which new emergency money will flow in.  The result is stalemate.

Markets like this are all about two things:

–individual stock selection, and

–at least some conviction about which way stocks will eventually break, once they decide to move either up or down again.

As far as stock selection is concerned, I think the two major areas to look at now are secular growth names in technology and consumer firms that serve average Americans.  It may also finally be a time to take a more serious look at the EU.

I think that the next major move in stocks is up.  Of course, I always think that.  But that hunch tells me what areas to look in.  It also makes me look extra hard for evidence to the contrary, because–other than having terrible stocks–it’s my greatest vulnerability.