Another Earnings Season Starts
The market action of the past week brings to mind the meeting between Dorothy and the Scarecrow in the Wizard of Oz, “this way is a very nice way…It’s pleasant down that way too…Of course some people do go both ways”. After hearing Fed Chair Yellen indicate rates would stay low for a long time, an “in line” employment report and better economic data from Europe stocks rose to record highs. However, once the initial “euphoria” wore off from the jobs numbers on Friday, investors “went the other way” and dumped stocks. Hard hit were last year’s high flyers, as the OTC market fell 2.5% on the day. So which way next? The coming week will have plenty of earnings numbers for investors to review, housing data and no lack of Fed Governors chatting at a conference. The economic data both here and abroad, while not terrific, is certainly not getting to the point where a recession is around the corner. As long as the economic data remains good, any market drop is likely to be relatively short-lived. That won’t stop investors from going in various directions.
From the market lows of 2009, the OTC market has steadily performed better than the SP500, climaxing with a rally into the end of 2013. Even after a February correction that matched that of the SP500, the OTC market has taken on a decidedly negative tone beginning in March. Will the OTC market lead the rest of the market lower? Over the past months I have highlighted the high valuations of the markets, but that rarely marks “a top”. Others have pointed to a high level of borrowings by investors to buy stocks. However that margin activity tends to follow and not lead stocks. In a few weeks the calendar will flip to May, when everyone will be talking about “selling in May and going away”. There is a seasonal tendency for stocks to do poorly from May to October, and that is especially pronounced in mid-term election years. According to S&P Capital IQ, since 1945 the mid-term election summer months are decidedly worse than average summer months. That said, as long as the economy continues to hold together, market declines that are not accompanied by recessions tend to snap back quickly. So, while a paring of some portfolio holdings may be in order, a better tactic over the coming months will be to rotate toward quality companies at better prices than maybe we are seeing today.
The bond market continues to dance to its’ own tune. Even the better employment numbers or manufacturing reports earlier in the week did little to push investors away from bonds. Yields continue to trade between 2.5 and 3% on the 10-year bond. Save for a few weeks here and there over the past two years, the bond model has been “green” for bond investors. Although last year saw a small decline in the bond “averages”, much of that loss has already been reversed this year. Corporate bonds should remain a good investment choice as balance sheets are still improving and economy is growing. Bonds have been much better this year as a counterbalance to stocks, rising as stocks fall, while declining a bit when stocks rise.
The high whine that is coming from the market is a downshifting from the high growth stocks to the “Steady Eddie” companies. The OTC market is the representative index for high growth, containing technology, biotech and internet related stocks. Relative to the SP500, the OTC markets has lost the last four months of outperformance. Filling the void are the international markets and within the SP500, utilities and consumer staples. The defensive nature of the market leaders is also pointing toward a correction that may take a few months to unwind and more than just a few percentage points from the popular averages. What is surprising about the better performance from international markets is that it is occurring in the face of a stronger dollar. Although down slightly from yearend levels, the dollar has been rallying since mid-March, at about the same time that EAFE holdings began besting the SP500. Usually US investors holding international stocks perform best during dollar weakness. This change, after a long bout of relative weakness, could be initial signs that international is ready to take some leadership in the markets.
The broad market may be taking a long-term break from the relentless rise of the past year. While “cashing out” may not be the best choice, reducing exposure to the former “hot” parts of the market and moving toward more “value” stocks may allow investors to weather the bumps in the road ahead. Bonds should also provide a cushion to stock market declines as well.
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.