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.

 

 

Jim Paulsen: lower lows, but not by much

Jim Paulsen, equity strategist for Wells Capital Management, an arm of Wells Fargo, gave an interview on CNBC yesterday.  It’s well worth listening to.

His main points:

–the stock market decline we’ve seen since November is all about adjustment to lower future earnings growth prospects.  This is being caused by the resumption of “normal” growth as the bounceback from deep recession is completed.  Another aspect of the return to normal is the economic drag from gradual end to extraordinary monetary stimulus, at least in the US.

In Mr. Paulsen’s view, the S&P 500 can trade at 16x trailing earnings in this new environment, not the 19x it was at two months ago.

–we may have seen the lows for the year last Wednesday at midday (1812 on the S&P 500).  More likely, the market will revisit those lows in the near future.  It will break below 1800 on the S&P, creating a fear-filled selling climax.

–assuming, as he does, that the S&P will end the year flat, i.e. around the 2044 where it closed 2015, a buyer at yesterday’s close would have a 9% return (11% dividends) from holding the index by yearend.  A buyer at 1800 would have a compelling 14% (16%) return.  11% might be enough to attract buyers; 16% surely will be.

–2017 will be a stronger year for earnings growth than 2015, implying that the market will rise further as/when it begins to discount next year’s earnings growth.

–the current selloff will trigger a market leadership change.  The new stars will likely be industrials, small-caps and foreign stocks.

a change in market leadership?

Very often, when the stock market makes a significant low and begins to rebound, a change in market leadership also takes place.  A new group of individual stocks and sectors emerges as the strongest performers as the market rises, sometimes emerging from areas least expected by conventional wisdom.  At the same time, at least some of the prior market stars are left by the wayside.  In my experience, the left-behind phenomenon occurs much more frequently.

It isn’t 100% clear that the recent market decline has been significant enough to be one of these transformative moments, although the drop of around 15% in the S&P from its intraday high last November to (what we hope was) the intraday low on Wednesday is the largest fall we’ve seen in some years. Still, it doesn’t cost anything to observe and analyze stock price movements to try to uncover new trends.  And if there were one time we should be extra-sensitive to deviations from the prior norm, this would be it.

(Monthly performance records of the S&P 500 by sector going back for years can be found on my Keeping Score page.)

Has the market really bottomed?  The intraday plunge in New York trading on Wednesday, followed by sharp rises around the world on Thursday and more so far today is the typical bottoming/rebound pattern.  So my guess is Yes.  Typically, the market will repeat the pattern we saw in the S&P last August-September–that is, a rally for several weeks, followed by a return to the vicinity of the prior lows and then a stronger rebound.

Will Energy and Materials lead on the way up?  I find that hard to believe, but both sectors have been drubbed over the past year or more.

Will Healthcare and Consumer discretionary lag?  That wouldn’t be my first instinct, either.  But the important thing isn’t what I think, it’s what the performance numbers begin to say in the coming weeks.

Other possibilities?

My guess is that we’ll find more separation of companies on the Millennials vs. Baby Boomers theme.   We may also see a sharper distinction between companies born out of WWII and whose managements have resisted structural change vs. those firms, both old and new, who have embraced the internet, mobile and the cloud.  Small may begin to outperform large.

 

 

timing the stock market

In its simplest form, timing the stock market means trying to figure out when stocks are either very expensive or very cheap and acting on your conclusion by selling stocks at the high points, holding cash for a while and backing up the truck to buy them again when prices are at their lows.

Two problems with market timing:

–it’s risky.  Historically the bulk of the positive returns from owning stocks occur on about 10% of the days.  Missing them can be devastating.

–it’s difficult to do.  In fact, in almost thirty years in the business I’ve never met a successful market timer.  I’ve encounter lots of unsuccessful ones, though.

There are professionals who are good at calling market tops.  Some are good at calling bottoms.  But I don’t know anyone who can do both.  More typical is the portfolio manager who “helps” his clients by raising a ton of cash on his view that the market is toppy, is psychologically unable to admit his mistake as stocks continue to rise and whose successor gets the task of cleaning up the resulting performance mess.

Relevance?

I have no idea where the strong negative emotion driving stocks lower globally is coming from.  So I think it’s best to stay on the sidelines until the craziness burns itself out.

Still, I noticed a couple of things about yesterday’s trading that suggest a bottom may be approaching.

–the S&P 500 broke through support at 1865 or so at the open and in short order found itself at the next support level of around 1815 at lunchtime.  The market made an immediate reversal and closed right around (just below) the former support.

The next support below 1815 is at 1870 or so.  We’ll see in the next few days whether the S&P can either recover above 1865 or hold above 1815.

–some stocks that I don’t hold but which are on my screen went crazy yesterday.

SCTY fell by -12% in the morning but closed up by almost +9% for the day.  That’s a 20% intraday swing.

LC fell by -9% in the morning but closed up by +8% for the day.  That’s a +17% intraday swing.

Yes, these are speculative stocks.  And they’ve been pummeled during the market downdraft.  But wild intraday swings like this are most often found at market turning points.

What to do?

I’m starting to comb through my portfolio for stocks that have held up well during the downturn to date and thinking about switching them for more interesting stocks that have been slammed over the past couple of months.  I’m not doing anything yet.  And I’m in no way contemplating making basic changes in portfolio structure.  But there may be an opportunity developing to upgrade at reasonable prices.

 

 

 

a market of stocks or an overall stock market?

my worry

This is the question I was writing about a few days ago.

The outstanding characteristic of the US stock market vs. other national markets during my career has been that Wall Street has been, almost uniquely, dominated by stock pickers.  While political or macroeconomic concerns occasionally arise, the focus of the vast majority of stock market participants has been on the merits (or lack of them) of individual stocks.

Many veteran stock pickers on the sell side have either retired or been laid off over the past several years, however, and institutional pension money allocated to active investing has increasingly been funneled to trading-oriented hedge funds or other “alternative” investment vehicles in a so-far vain attempt to close the gap between the assets they have on hand and the minimum they need to meet their present and future obligations.

The result of this change has been an increasing influence on stock prices by computers that react to news of all sorts as it is published and by short-term human traders sensitive to macroeconomic trends but with (to me) surprisingly little knowledge of the ins and outs of individual companies or industries.

My worry has been that–as has happened in other countries–the macro woes of sectors like Energy and Materials, or perhaps the demise of the post-WWII industrial corporate structure, overwhelm the attractions of even large micro pockets of strength in, say, IT.

last Friday

My worries have no basis in fact, at least so far, if last Friday’s trade is any indication.

The S&P 500 was up by 1.1%, the IT-heavy NASDAQ by 2.3%.  However, consider the performance of the following companies that reported earnings before the open:

Microsoft         +10.0%

Alphabet (aka Google)          +7.7%

Amazon          +6.2%

athenahealth   (a weak performer before Friday)      +27.5%.

 

Compare that with:

VF          -12.9%

Skechers          -31.6&

Pandora Media          -35.6%%.

 

Two things stand out to me:

–most of these reactions are extreme, suggesting that the market is reacting to the news rather than anticipating it, and

–the market is very willing to differentiate sharply between individual winners and losers.

 

My conclusion:  we as individuals can still ply our stock-selecting trade.   The reward for finding superior companies, however, may come all at once, and later than we have been used to in the past.

 

thinking about 2016: commodities

commodities

In the broadest sense, commodities are undifferentiated products or services.  Producers are price takers–that is, they are forced to accept whatever price the market offers.

Commodity products are often marked by boom and bust cycles, that is, periods where supply exceeds demand, in which case prices can plummet, followed by ones where supplies fall short and prices soar.

 

For agricultural commodities, the cycle can be very short.  For crops, the move from boom to bust and back may be as little at one planting season, or three-six months.  For farm animals, like pigs, chickens or cows, it may be two years.

 

For minerals, which right now is probably the most important commodity category for stock market investors, cycles can be much longer.  Base and precious metals have recently entered a period of overcapacity.  The previous one lasted around 15 years.  One might argue that prices for many metals have already bottomed.  I’m not sure.  But I think it’s highly unlikely that they will rise significantly for an extended period of time.

 

Oil is a special case among mined commodities.  Lots of reasons

–the market is huge, dwarfing all the metals other than iron/steel.

–there’s a significant mismatch between countries where oil is produced and where it’s consumed.

–there’s one gigantic user, the US.

–for many years, there was an effective cartel, OPEC, that regulated prices.

To my mind, the most important characteristic of oil for investors at present is the wide disparity in out-of-pocket production costs between Saudi crude ($2 a barrel) on the one hand, and Canadian tar sands ($70? a barrel) on the other.  US fracked oil ($40? a barrel) is somewhere in the middle.  The lower-cost producers have gigantic capacity, and the potential to ramp output up if they choose.  This wide variation in costs makes it very difficult to figure out at what price enough capacity is forced off the market that the price will stabilize.  For example, Goldman, which has an extensive commodities expertise, has argued that under certain conditions crude might have to fall to $20 a barrel before it bottoms.

 

The oil and metals situation is important for any assessment of 2016, because:

–about 25% of the earnings of the S&P come from commerce with emerging markets, many of which depend heavily on exports of metals and/or oil for their GDP growth

–the earnings for about 10% of the S&P 500–the Energy, Materials and Industrials sectors–are positively correlated withe the price of metals and oil.

–a low oil price is a significant economic stimulus for most developed countries, meaning margins expand for companies that use oil as an input  and consumers spending less on oil will have more money left to spend elsewhere.

As a result, one of the biggest variables in figuring out earnings fo the S&P next year will be one’s assumptions about mining commodities prices, especially oil.

 

More tomorrow.

 

 

thinking about 2016

At present, world stock markets appear to me to be obsessively focused on the smallest details of the here and now.  This may be fine for short-term traders, but getting caught up in this mindset is the surest recipe for trouble for us as long-term investors.  Our biggest advantage against professional traders is taking a longer view.

So it makes sense that we should be shifting our focus toward the new year, even though (actually, because) I think the markets have yet to do so.

My thoughts (which will be presented in more detail in my yearly strategy posts in a few weeks):

interest rates

Rates will be somewhat higher a year from now than today.  The Fed, however, has made it clear that the journey back from emergency-low rates to normal–that is to say, from zero to perhaps 2% for overnight money–will take years.  In theory, higher rates make fixed income relatively more attractive to investors than stocks, mimplying that the stock market suffers price-earning multiple contraction.  I’ve written a number of times, and I still believe, that virtually all of this contraction has long since been factored into today’s stock prices.  Even if this is incorrect, next year’s rise is going to be quite small.  Absent a crazy panic, the potential headwind from PE contraction is likely to be extremely small.  

world economies

–the US will continue to be strong

–the EU has bottomed and will gradually strengthen, so next year will be better than this

–China ‘s transition from export-oriented growth to expansion led by domestic consumer spending is happening at a satisfactory pace.  While traditional economic indicators, which are generally speaking all focused on exports (the wrong place to look), continue to be ugly, overall economic growth next year will be at least as good as in 2015

–natural resource-producing emerging countries will continue to have troubles.  The main issue will not be lower commodity prices.  It will be dealing with excessive debt taken on when companies/governments believed in a perpetual commodities boom, and adjusting private/government spending downward to deal with lower levels of commodity income.

 

More tomorrow.