Quarter End

PaulNolte-2The curtain drops on another quarter, although many in the audience may be wondering exactly what happened in the  opening act for the year. Global politics and weather seemed to be center stage, as poor economic data was blamed on the weather and large market drops surrounded the Russian saber rattling. The intermission will be rather short, as late in the week investors will get to see the employment report and various measures of manufacturing health. Whether the employment figures hit their target for the month may be immaterial, as the trend continues to improve at a frustrating slow pace. This is in-line with the weekly jobless data and historically coming out of a debt crisis like that of 2008. A quick scene change from the macro economic data to the corporate earnings season the following week should provide some additional information on how companies are acting in this economy. Investments have been poor, while corporate buybacks and dividends are the “go-to” script to keep earnings looking good. The drama is really only just beginning.

A large dichotomy is appearing between the SP500 and OTC markets. The “popular” SP500 saw a modest decline on the week, while the OTC market had its worst week in nearly two years. The OTC market tends to have more volatile issues that investors flock to when markets are doing well, and run from when things turn south. The big decline in OTC stocks in 2013 marked the beginning of “growth” stocks performing poorly relative to “value”, even though the OTC market rose during that period. It was not until the Fed talked about tapering their bond buying program that growth once again took the lead. Now, six months into the tapering program, the markets have once again shifted. While unnerving, this rotation in market leadership is healthy. The net number of advancing to declining stocks continues to rise; overall momentum remains relatively strong and volume is supportive of nothing more than modest market declines. That is not to say the markets are entirely out of the woods, as investors sentiment is once again very bullish. Market declines over the past two years so far have been met with buying, keeping corrections modest in size. There will come a time that a “real” correction will unfold of 10% or more, but so far the indicators are not pointing in that direction.

One of the biggest stories of the quarter has to be the bond market. It was thought that interest rates are near all-time lows and with the Fed backing away from their QE program, interest rates had only one direction to go – higher. Even comments from Yellen that rates would be rising roughly six months after the end of tapering have done little to force investors out of bonds. Thirty year bond yields have fallen half a percent and utility stocks are up significantly so far this year. Where did everyone go wrong? International markets remain messy, especially emerging markets. Political risks are rising globally and the US bond market remains the broadest and deepest market for global investors looking for safety.

The rotation from growth to value has some implications for the various industry groups that make up the SP500. When investors think “growth”, they usually look at technology stocks. However this time around, the “growth” has been led by healthcare stocks, especially the biotech sector. This can be seen in last week’s action, as technology issues did decline, but much less than healthcare and the general OTC market. The “safe” stocks in utilities and even telecom saw gains last week as investors once again rotated away from the more volatile issues. Investors may be beginning to recognize the value in international stocks, as overseas holdings saw large gains. For the past 2½ years, emerging markets have traded sideways in a 15% range and have traded well behind the SP500 for the past four years. From a valuation standpoint, emerging markets are cheap, however have lacked any positive momentum. One week won’t change that, but the
dramatic performance last week makes international investing worth keeping an eye on in April. Other parts of the market that bear watching are the defensive parts of the US markets, as utilities (and bonds) continue to do well.

The end of the quarter may also be signaling the end to the long outperformance of biotechnology stocks in favor of international stocks. Leadership in the US is shifting toward more the more conservative/defensive parts of the markets. As a result, bond investors should also reap the benefits of the shift toward safety.

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