“The problem with Socialism is you eventually run out of other people’s money”
The start of the second quarter was greeted by a surprisingly weak employment report on Good Friday. The market bears came out of hibernation and immediately began growling for a market correction after March non-farm payrolls showed an increase of only 126,000 jobs vs. Reuters' expectations of 245,000. After a brief sell-off at the opening bell on Monday, the market has rallied back, and it continues to "climb the wall of worry".
The current economic recovery that began in March 2009 is now six years old, and it's showing some signs of fatigue. Given this fact and the current market volatility, you may be asking, “What should I do as an investor at this market juncture?” To answer this question, let’s take a look at some of the current market headwinds facing investors:
• Europe has essentially been in a depression since the financial crisis of 2008. The dollar has appreciated about 20% against the Euro since June 2014 as the European Central Bank began its own Quantitative Easing (QE) last June to spur growth and stave off deflation. QE is buying bonds with money printed by the central banks in order to push down long-term interest rates and encourage investment. The Bank of Japan was the first to engage in QE about 14 years ago, and it's resulted in a period of secular economic stagnation for Japan (perhaps an understatement). Our Federal Reserve Bank began its QE policy in 2008 with QE 1, and then QE 2 and a QE 3 in June 2011 (Europe, as you may recall, was on the verge of disaster). Since then, the Fed has added over 4 trillion of US bonds/debt to its balance sheet, and we've continued to ignore the market mavens and former colleagues call to sell high coupon bonds. Instead, we've bought any spikes in yields for retiree and trust accounts, most recently in December of 2013 when the 10-year Treasury yield approached 3%.
• The dollar’s strength has caught many investors by surprise and has led to a precipitous drop in the price of oil from about $99 in June 2014 to current levels around $51. At CWM, we think the strong dollar is a sign of continued strength in the US and not just a flight to quality.
• US Treasuries have rallied the past year, particularly the long end. The 10-year Treasury is still below 2.00%. The US 10-yr @ 1.91% vs. Germany's equivalent @ .016% and Japan's equivalent @.365% as of this writing.
Chief Economist of Gluskin Sheff, David Rosenberg, thinks the stronger dollar is already acting as a tightening mechanism (higher interest rates) as US corporate profits have begun to get squeezed. He states, “The Fed would be well advised to sit back, watch, and assess--- and let the dollar do the heavy lifting.” Corporate America, according to some estimates, lost over 18 billion in Q4 2014 due to the stronger dollar. The market is an efficient pricing mechanism, and we think it has adequately priced in the effects of a stronger dollar on corporate earnings going forward.
In his April Market Insights, Rich Bernstein (a market bull) of Richard Bernstein Advisors begins by stating “Beauty is in the eye of the beholder – the same can be said for equity valuations”. His conclusion based on his quantitative work: “the market is valued as it would typically be for a mid-cycle period, roughly fairly valued”.
This bull market is one that many market pros seem to hate--market pullbacks of 5 - 8% are healthy. Once the Fed makes its move, perhaps later this year, we think the markets will act more decisively. We suspect that liquidity will not be shut off by Central Banks in the form of significant tightening this year.
The following highlights CWM’s investment strategy for the balance of 2015:
• We're overweight growth vs. value. We expect the US market to move sideways as earnings estimates are too high. German and Japanese markets may play some catch-up.
• In Q1, we closed out our tactical overweight in TLT, (20+ yr. US Treasury Bond ETF). Its outperformance surprised us as we merely saw value in the long-end of the yield curve. The return in TLT was accentuated by QE in Europe -- it moved from 101.72 on 01.02.14 to over 131 on 01.06.15.
• We have shortened bond maturities and duration for the first time in nearly a decade. However, we think the move higher in interest rates will be gradual—do not fret. GDP growth is still anemic compared to prior recoveries and as such, the market has become addicted to QE. There is too much capital, however, chasing too little value in bonds, especially short duration bond funds ( i.e. asset bubble).
• We have a tactical overweight in Germany and Japan and expect these markets to outperform the US in 2015 given the dollar strength. The strong dollar favors strong manufacturing, exporting countries such as Germany and Japan.
• Cheap energy stocks/drillers do not represent value in our opinion. Value is determined by cash flow and assets, and both are at risk in this sector. We leave it up to the best-in-class private equity and hedge fund managers to determine what represents good value in this sector. We sold our remaining energy MLP in early January 2014 given the inverse relationship between a strong dollar and oil/gas prices.
• We think writing covered calls at the upper end of the current trading ranges is a prudent strategy in a range-bound market---enhancing total return with income from premiums while lowering cost basis and volatility.
• We continue to favor technology, particularly medical technology, and healthcare at this juncture.
The larger question on our minds is can central banks usher in a new era of economic stability marked by low rates, modest growth, and stable inflation? Only time will tell the economic implications of this great monetary experiment called QE. Like Japan, we could be headed for a prolonged period of secular economic stagnation. Our Federal Reserve Bank Chairman, Janet Yellen, recently voiced such a concern. Much of the excess capital created by our Federal Reserve Bank QE policy has yet to find its way back to Main Street USA in the form of job-producing growth and capital goods expenditures. We think, however, Good Friday's employment report is just another lumpy employment number and not a harbinger of a weakening economy. At this market juncture, it’s time for the consumer to grab the baton it’s being handed and finish the last leg of this economic recovery with strength.
*note: the market prices quoted above are obtained from cnbc.com. Certain quotes were obtained from Investor Business Daily and Bloomberg news service and are for informational purposes only. We assume no responsibility for the timeliness, accuracy, or truthfulness of content derived from unaffiliated third-party sources as stated under "Disclaimer of Warranty" under the site's "Terms of Use".
Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk. Therefore, it should not be assumed that future performance of any specific investment or investment strategy (including the investments and/or investment strategies recommended or undertaken by Cambridge Wealth Management, LLC) will be profitable or equal the corresponding indicated performance level(s).