Spring Warm Up

PaulNolte-2Russia annexing Crimea, slower US economic growth, slower growth in the economic engine that is China, projections for lower earnings growth and maybe higher rates early next year are of little concern to the markets. Friday morning the markets hit fresh all-time highs before finishing lower. The highlight of the week was three words uttered by Yellen in response to when interest rates might rise – “around six months” after the end of tapering. Interesting though was the removal of employment targets and comments that indicated the Fed was once again “data dependent”. Given the historical ability of the Fed to project the economy for the next six months, let alone the next year, the prospects of higher rates remain relatively murky. The coming week wraps up a volatile first quarter with little meaningful economic data. Investors will likely be bracing for the deluge that starts every quarter. From the employment to earnings data, the first month of each quarter tends to be busy for the analyst and economic community. The rest of us will be watching the weather charts for the “big thaw”.

After five plus years of market gains and a terrific year last year, the markets are beginning to look a bit rough around the edges. The new market highs are being met with fewer stocks hitting highs as well, indicating fewer stocks are participating in the party. However, that is contrasted with the net number of advancing to declining stocks that continue to move steadily higher. So how can the net number be rising, while few stocks hit highs? The market is in the process of rotating from the recent winners to the recent losers, which have a ways to go to hit highs. Momentum is definitely waning, but even that measure has gone from very high levels to very low levels three times since the start of the year. This is the manic nature of investors today, which can also be seen in the sentiment readings. From individual investors to institutional managers, sentiment has swung from bullish to bearish and back again just since the start of the year. This “whippy” action is tough on investors with a long-term horizon, but does provide some pockets of opportunities for various securities that get unjustly sold. The markets remain in a corrective pattern, going dramatically sideways without completely falling apart. Many of the indicators still point to a correction and not the start of a large decline in stocks.

Bond investors were spooked by Yellen’s comments that rate increases might actually occur ahead of what investors originally anticipated. But after yields spiked higher during her news conference, by the end of the week, rates were essentially unchanged. What did change was the inflationary backdrop. Commodity prices fell, especially gold prices and utility stocks (an equity proxy for bonds) held relatively firm all week. The bond model continues to point to still lower yields, even though Ms. Yellen has said otherwise. Keeping rates relatively low is the lack of robust recovery indicators in the market. For every good economic report, there is at least one to offset. The global economy does not look particularly strong either, keeping investors interested in bonds.

The markets daily swings has done little to move the needle on the various economic sectors within the SP500 or in the major industry groups. When comparing the SP500 performance to the major asset classes, with the exception of emerging markets, all are fairly close in the performance derby this year. If there is a tilt, it has been toward value over the past month and away from growth. Typical “growth” groups are technology, biotechnology and some consumer related issues. The “value” side tends to favor utilities, consumer staples and pharmaceuticals. It can be hard to pigeon-hole groups and even stocks into these broad classes, as defining characteristics can apply equally to certain stocks. Without the development of clear leadership in the market, as evidenced by fewer new highs outlined above, it will be hard for the markets to make significant headway. By the same token, without a change in the market dynamics, the declines have tended to be good opportunities to buy. The upcoming earnings season will be one to watch as investors are getting tired of companies buying back stock and will be looking for “real” earnings, rather than those manufactured by reducing the number of shares outstanding. The second quarter could be an interested time.

We are sticking to the correction thesis, as stocks remain volatile within a relatively narrow sideways range. Little has changed in the broad markets, so large US stocks continue to dominate performance. Bond investors should be comfortable in their holdings as significant losses are not likely over the coming months.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.