Tag Archives: Portfolio management

surviving the next twelve months (iv)

June 12, 2015 By in bond market, Constructing a Portfolio, Portfolio management, securities markets, stock market, Strategy Tags: , , , , , , , , Leave a comment

what makes me optimistic

I’m a growth stock investor.  So I’m optimistic by nature.

More to the point, the two worries about thinking stocks will go sideways to up as the Fed normalizes interest rates are that:

–recovery in the US may continue to be sub-par..  

If so, the normalization process is going to take a looong time, since the Fed’s goal is to raise interest rates at a slow enough pace that the economy in unaffected.  Yes, the Fed may make a mistake, but the error it typically makes is to wait too long to raise rates, not to raise them too fast.

In addition, there’s serious discussion in economic circles that maybe the way we have measured economic progress in the US in the post-WWII era has passed its “use by” date and isn’t capturing what’s going on in an Internet-centric world.  After all, it took many years for government data to acknowledge that personal computers enhanced productivity and increased consumers’ well-being.  We’re now in the midst of a much greater period of change–the baton-passing from Baby Boomers to Millennials and the demise of the post-WWII corporation designed on the model of the 1940s Army.

Maybe the economy is a lot hardier than we now think.  If so, the strength of earnings growth may not be the issue the market perceives it to be.

–the rest of the world is a mess…

therefore the 50% of S&P 500 earnings that comes from abroad will  be a source of disappointment.

As far as commodity-based emerging economies are concerned, “mess” is probably an apt characterization.  But they’re (thankfully) only a tiny portion of the foreign 50% of S&P earnings.  The key areas for the index are Europe and Asia, especially China.

As far as Europe goes, there’s evidence that the worse of the recession is behind it.  The euro may have bottomed against the dollar, as well.  The EU is still struggling with the problem of Greece.  But that’s not because Greece is a key economic driver for the EU (quite the opposite), but because Brussels fears that allowing/forcing one member to leave the union will set a precedent, and encourage separatist political parties elsewhere.

I have no idea whether Greece goes or stays.  But I think that the negative economic consequences for Greece–Cuba is the only analogue I can come up with, and it’s not a very good one (Argentina?)–of leaving the EU will be so devastating for the country that Grexit itself will silence separatists.

There are also the first signs of economic stabilization in China.

So maybe the half of S&P earnings that come from abroad also won’t be as bad as the market now thinks.

an active strategy

areas to avoid–stocks whose main attraction is their dividend

areas to emphasize–Internet economy, firms catering to Millennials

 

 

surviving the next twelve months (iii)

June 11, 2015 By in bond market, junk bonds, Portfolio management, securities markets, stock market, Strategy Tags: , , , , , , , Leave a comment

In the past in the US when the Fed has raised interest rates from recession-emergency lows, bonds have gone down and stocks have gone sideways to up.

Will this time be an exception?   …another way of saying, Will stocks go down this time around?

The generally accepted explanation of the divergence between stocks and bonds while the Fed is normalizing interest rates after a downturn is that the negative effect of higher rates is offset, in the case of stocks, by the positive effect of strong earnings growth.  Bonds–other than junk bonds, or municipal bonds–don’t have this offsetting factor.  So for Treasuries the news is all bad.

(There are at least two reasons why interest rates matter for stocks:

–broadly speaking, people (me being a possible exception) don’t actually want to own stocks.  What they want is to own liquid long-term investments so they can fund their retirements and send their kids to college.  Those can be either stocks or bonds.  A decline in the price of bonds makes them more attractive, taking some of the shine off stocks.

–in broad conceptual terms, the worth of a company should be related to the value in today’s dollars of its future earnings.  To the extent that investors use today’s interest rates to discount future earnings back to the present, rising rates will result in lower present values.)

 

I remain squarely in the “sideways to up” camp, but I can see, and am monitoring, two possible worries that may weaken the case for s-t-u:

–in what has been to date a sub-par rebound from recession, earnings growth may not be as strong as in prior recoveries, and

–the S&P 500 is a global index, about half of whose earnings come from abroad.  Even if US-sourced earnings are great, the same may not be true for foreign-sourced.  In particular, an increase in the value of the dollar vs. the euro caused by increasing interest rate differentials (the worry of the IMF and World Bank) could mean a lower dollar value for EU-sourced earnings (which make up about a quarter of the S&P 500 total).

More tomorrow.

 

surviving the next twelve months (ii)

June 10, 2015 By in bond market, Constructing a Portfolio, currency markets, Current Market Thoughts, growth vs value, stock market, Strategy Tags: , , , , , , , Leave a comment

two types of tightening

The Fed raises rates in two different situations:

1  to slow down an overheating economy.  This is not where we are now.  In the overheating situation, the economy is expanding at an above-trend rate.  Inflation is accelerating.  Wages are rising rapidly.  The stock market is frothy.  The long bond is trading at inflation +2% – +3% (meaning a nominal yield of 4% – 5%, in a 2% inflation scenario).

As the Fed ups short-term rates, what  follows is a garden-variety recession/bear market.  Bonds go down.  Stocks go down.  The damage to stocks is worse than the damage to bonds–often by a lot.

Again, this is not the situation we’re in now.

2)  to restore money policy to normal after a period of extreme easing aimed at ending a recession or combating a severe economic shock.  That’s where we are now.

 

In situations like this, bonds go down but stocks go sideways to up.  There’s no theoretical reason I can see for the latter behavior.  It happens, I think, because, unlike the overheating situation,  the Fed doesn’t intend to bring growth down dramatically.  It just wants to wean the economy off a sugar high of very easy credit.

Two things make todaydifferent from past rate normalization periods, however:  the amount of easing has been very large and of unusually long duration; and dysfunction in the legislative and executive branches in Washington has meant fiscal policy has failed to do its part come to the country’s support, other than in the earliest days of the financial crisis.

Some argue that beause of this, today’s situation may be different enough that the past won’t be a sure guide.  I’m going with history.  But I take th point that we can’t just be on cruise control.

two different portfolio responses

The two types of tightening call for different stock portfolio construction, in my view.

In today’s world:

–bond-like stocks will probably not do well.  Years of ultra-low interest rates have forced Baby  Boomers to search for income in the stock market.  As rates rise, and bonds become increasingly attractive, some Baby Boom money will return to bonds.  At first, the reverse flow may only be new money.  At some point, however, Boomers may begin to liquidate their income stocks.

–rising rates may make the dollar spike.  In fact, the IMF recently expressed this fear in an emphatic plea to the Fed to postpone the start of the rate normalization process into 2016.  It’s not clear to me that the dollar will appreciate much further, however.  But if it does, stocks with foreign exposure will become less attractive, since the dollar value of their foreign earning power declines.  On the other hand, foreign companies with large US exposure become more attractive, both to local investors and to you and me.

–companies with their own special growth story become more attractive than those that are mostly dependent on the general business cycle for their oomph.  Cloud computing and Millennial favorites should be relatively fertile fields.  Arguably, the market’s preference for growth stocks over value has been in place for some time.  But the preference for the former should intensify.

 

More tomorrow.

navigating the next twelve months (i)

June 8, 2015 By in Current Market Thoughts, Portfolio management, Recent Market Action, Strategy Tags: , , , , , , , , , 3 Comments

As I wrote on Friday, I think we’re at an inflection point in the US stock market.  It seems to me the market is now beginning to take seriously the idea that the Fed will soon be beginning to raise interest rates from the current near-zero.

In one sense, this is not Wall Street’s first rodeo.  There are plenty of times in the past when the Fed has been reversing emergency monetary accommodation applied during a recession.  The investment community has already sifted through them ad nauseam.

On the other hand, the extent and duration of the current monetary easing are both without precedent.  At the same time, the way the market factors new information into stock prices has changed considerably over the last decade.  The goals and risk preferences of the Baby Boom, the most powerful retail influence on stocks, have shifted as well, as that generation has aged.

Boomers are more interested in income than in capital gains.  Hedge fund managers and algorithm-fashioners seem to have very short time horizons–almost reacting to information as it hits the news media rather than anticipating it.  (I almost cringe to write this last.  It reads a lot like the criticisms made by elderly patrician money managers of the past (whom I made fun of at the time) who held stocks for decades at a time and were struggling to adjust to the faster-paced market of my early years on Wall Street.  Still, I think what I’m saying is correct.)

Therefore, I think, we can’t just blindly apply generalizations from the past to our present situations.

two types of tightening

It’s important from the outset to distinguish between two types of Fed tightening:

–restoration of the real rate of interest from negative to positive as the economy recovers from recession, and

–raising the real rate of interest substantially above inflation in order to slow down an economy that’s potentially overheating.

Today, we’re dealing with the first kind, not the second.

what the past tells us

During past periods of Fed tightening of the first type, stocks have been volatile but have generally gone sideways to up.  Bonds, on the other hand, go down.

This, in itself, has implications for stock market strategy.  Stocks that resemble bonds the most tend to do particularly badly; (at least some of) those that resemble bonds the least do the best.

More tomorrow.

 

 

the May 2015 Employment Situation

June 5, 2015 By in bond market, Constructing a Portfolio, Current Market Thoughts, Employment Situation report, securities markets, stock market, Strategy Tags: , , , , , , , , Leave a comment

the May Employment situation

At 8:30 am, est, this morning the Bureau of Labor Statistics of the Labor Department made its usual release of the monthly Employment Situation.  The report showed the economy added +280,000 new jobs during May, substantially higher than economists’ estimates of +225,000.  Of the total, 262,000 positions were in the private sector, 18,000 in government.

Gains in government employment are almost exactly offsetting declines in mining/oilfield.

revisions

Revisions to prior months’ estimates added another 32,000 to the tally.

Average hourly earnings were up by 2.3%, year on year, showing no acceleration from their recent tepid growth, despite the low current unemployment rate (5.5%) and the sharp employment gains.

why the report in important for investors

What I find interesting is the financial market reaction to the positive report, namely:

–S&P 500 future have declined modestly

–the US$ is up by about a percent against the euro and the yen

–gold is down a percent in dollars (flat in euros or yen)

–in pre-market trading, financials (higher interest rate beneficiaries) are doing relatively well, utilities (whose attractiveness as income vehicles is lessened by higher rates) relatively poorly.

the message

In other words, the message the market is taking from the ES is that the Fed is going to begin to raise short-term interest rates relatively soon (September?).

I think this ES most likely marks an important turning point in market psychology.  Since early 2009, investors have taken heart–and portfolio positioning cues–from the idea that interest rates were extremely unlikely to rise and might possible decline. Investors who adopted an appropriate portfolio structure have been rewarded by seeing rates fall to what were initially undreamed of low levels.

That period is over.

Now rates are highly unlikely to fall and may rise.  Although rates will doubtless rise very slowly and may reach “normal” at much lower levels than in previous economic cycles, this is an important distinction.  It implies that the market will (finally) reorient itself into anticipation of rising rates.  It doesn’t need to have a precise idea of where rates are headed.  The key thing is that the easing trend of the past seven years or so is behind us.

More on Monday.