playing cyclical recovery

Yet another slow-motion human catastrophe seems to be starting to play itself out in the US. Yes, Trump’s strange attempt to undermine the finances of the American university system, one of our crown jewels, by barring its highest-paying students from attending, disappeared almost as soon as it was unveiled (to be fair, my guess is Trump had no idea what he was doing; he just wanted to burnish his xenophobe credentials). But the real economic/social issue is the rolling start to the national school year next month. Just as with mask wearing, Trump appears to be insisting on resuming school in person and on schedule, which seems to me to be a recipe for another surge in coronavirus cases, similar to the one resulting from Trump’s urging southern and western states to reopen too early.

I think the stock market reaction to this will be twofold: to stop the rotation away from secular growth to domestic cyclicals, and to reconsider whether or not the latter’s current prices are too high.

What I have tended to forget is that, possibly ex the UK, the US response to the coronavirus has been by a mile the worst in the world. Europe and Asia are already starting to rebound at the same time equity investors are coming to grips with the fact that Washington–and a number of state governors–are about to inflict another round of damage to GDP.

Anyway, my thought is to reduce my exposure to what I see as very expensive tech names and build up cyclical exposure–in the EU and Asia.

the market is rotating…

…away from secular growth and toward business-cycle sensitives.

Over the past five trading days, including today (I’m writing just after noon), the Russell 2000 is +6.8% and the NASDAQ is up +2.4%.  Half of the relative gain has come so far today.

Unless/until we get bad coronavirus news, I think this movement will continue.

What to do?

The safest thing to do is to stick to your long-term strategy.  Use this as an occasion to adjust holdings, not a cause.  I think the primary reason for the current move from secular growth to cyclical is the huge performance differential that has built up between the two indices, not a fundamental change in trend.  Sort of like the losing team getting a turn at bat.

On the other hand, for someone willing to put in the time and effort, I think this could be a counter-trend rally that goes on for a couple of months before reversing itself.  To pluck a number out of the air, it could mean a 10% relative gain from here for the Russell over NASDAQ.

As for me, about a month ago I bought a small amount of an R2000 ETF and a smaller amount of MAR.  That lost me a tiny amount of performance.  I added to both two weeks ago.  That has worked out better so far. I added more R2000 today, bringing my total shift to just under 10% of my portfolio.

If what I said two paragraphs up turns out to be correct–and if I reverse what I’m doing at the right time–I’ll have gained around 100 basis points in performance.  The figure would be much higher if we could see an end to Trump’s highly damaging economic policies, or if his election opponent weren’t a septuagenarian whose fastball appears to have lost a lot of zip.

is this enough reward to justify taking the risk of being wrong?   Unless you’re involved with your portfolio every day–and I am now that art school is  over (graduation tomorrow)–probably not.  But it keeps my hand in.

 

 

 

time for market rotation?

market rotation

We all understand what the winning formula for the pandemic stock market looks like:  overweight NASDAQ, underweight the Russell 2000;  overweight secular growth stocks with worldwide sales, underweight US-centric business cycle sensitives.

At some point, however, at least one of two things happens:

–evidence starts to build that the worst of the pandemic-induced slump in economic activity is past us.  Companies start hiring again; credit card sales start to pick up; houses begin to be sold…   or,

–the valuation difference between safe havens and pandemic losers becomes so great that contrarians begin to sell the former to buy the latter.

In either case, the market rotates away from what has been successful so far into something else.

Two questions:  when and toward what.

On the valuation front, year to date NASDAQ is down by 3% (among heavyweights, MSFT is +12%), the Russell 2000 is -27%.  Yes, this is the trend we’ve seen through most of the economically toxic Trump administration.  But the magnitude is different.  This is a huge gap in a short amount of time.

Nevertheless, despite the fact I would really like to shift my holdings away from recent winners, price action isn’t giving me the slightest encouragement to do so.

For me, the “toward what” isn’t really clear either.  So it may be that professional investors will take the very unusual step of simply raising cash and waiting.

As for me, I’m staying on the sidelines with the same tech/cloud-heavy portfolio.

 

a third factor 

A cardinal rule for investment success during my 40+ year involvement with stocks has been to avoid worrying too much about politics.  Think calmly and objectively instead.  It’s becoming difficult to ignore the increasingly bizarre and worrisome actions of the Trump administration, though, which are also taking on more and more of a 1984 tone.

Lack of attention to education, retraining workers and aging infrastructure–failings of both major political parties–are bad enough.

But now there’s Trump’s doubling down on his worst-in-the-world response to COVID-19, which has so far cost the US more deaths than all our armed conflicts since WWII.  (According to the Financial Times, 90% of these deaths were preventable had Trump not continually asserted the pandemic was not real.)

Then there are his recent threats to bar Chinese students from US universities and to deny Chinese-made goods entry to the US–more signature shoot-yourself-in-the-foot moves.  Perhaps more important in a pragmatic sense, Trump threatens a lot but does nothing.  To me, this is the worst of all possible worlds because it exposes his underlying weakness.

Finally, as an Army veteran I’m particularly disturbed that Trump is destroying the career of the Navy captain who rescued his crew when he found his aircraft carrier a coronavirus hotspot.  At the same time he’s pardoned a convicted war criminal and is now trying to have charges dropped against former General Flynn, who confessed to lying to the FBI to conceal his work as an agent of the Russian government.  In other words, Duty, Honor, Country and the content of one’s character mean nothing.

 

A rant, yes.  But there is a point.  The Hitler vibe is certainly not a positive for potential buyers of US goods and services in foreign markets.  Nor are indifference to human life and race hatred a big draw for foreign investment or tourism here.

 

 

 

 

 

 

 

 

 

 

 

 

market rotation: two types

market/sector rotation

Market rotation, sometimes also called sector rotation, is a shift in the pattern of sector outperformance in the stock market.  In 2016, for example, the S&P 500 favored defensive sectors over aggressive ones.  2016 produced the opposite result.

why

The market rotates for two basic reasons:

change in economic circumstances.  In early 2016, for example, Wall Street began to believe that the price of crude oil, which had been in free fall for two years, finally hit bottom at around $26 a barrel.  So oil stocks began doing better.  Similarly, investors now believe that the election of Donald Trump as president, meaning both houses of Congress and the White House are all Republican, signals the end of Washington dysfunction.  This implies a significant turn for the better in the US economy.  As a result, the most economically sensitive areas of the stock market have been doing better since Election Day.

valuation.  Professional investors often say that “trees don’t grow to the sky,” meaning that at some point sectors that are enjoying an economic tailwind become too expensive relative to those being buffeted by temporary headwinds.  At such times, they will begin to buy stocks in left-behind sectors almost entirely on the idea that as financial instruments they are relative bargains.

short/shallow vs. long/deep

Sector rotations based on valuation tend to be much shorter and shallower than those based on a change in economic circumstances.

the 2015 -16 example

In 2015,  the Healthcare sector rose by +5.2% and Energy fell by -23.6%.  The difference in performance between the two was a whopping 28.8 percentage points.

In 2016, Healthcare fell by 4.4% and Energy rose by +23.7%.  The performance difference between the two was 28.1 points.

what about today?

To me, the extent of the outperformance of the most economically sensitive sectors since the election has been so strong as to invite a market rotation away from them.  My guess is that this will be based mostly on relative valuation.  If so, the turn away from current market leaders will be relatively brief and the correction in these sectors relatively shallow.

For day traders, this will be a big deal; for you and me, not so much.  Our main concern will be the buying opportunity in cyclicals a correction in them will present.