A Spoonful of Sugar
Spoonfuls of lovin’ were passed around last week. A tentative agreement with Russia was fashioned last week too, brokered by France and Germany. Even before it is to start, rebel leaders declared they are not bound by the agreement. Talks for an accord on Greek debt are ongoing. Greece promised to do whatever they can to reach the accord. Finally, the G-20 financial chiefs endorsed strong stimulus measures by central banks to boost the weak global economy. With all the hugging and kissing, it was little wonder that the stock markets rose on the week. Even the poor economic news in the US had lipstick on it. For the second straight month, retails sales declined. Although consumers remain very upbeat about the economy and jobs, they are not opening their wallets and spending. Some of the decline is due in part to lower energy prices, but even stripping energy out, sales still declined. The coming week will have more speeches by Fed officials, inflation reports and comments from the central bank of Japan. It is expected that inflation will be negative due in large part to energy, however it will be important to see the “core” inflation rate (without food and energy). Japan will be watched closely on Wednesday as they announce their decision on rates and monetary policy. To date, they have been the most aggressive in buying national debt and are not likely to show any signs of slowing those purchases in order to boost inflation and hopefully consumer spending.
The markets interpreted all the news as good for stocks, pushing the SP500 to new all-time highs. Apple became the largest company ever, crossing $700 billion in market capital. Many believe the company can continue to grow and foresee Apple becoming the first to $1 trillion. Just to put it in perspective: Apple is worth more than GE, Wal-Mart, McDonald’s and GM combined. It is almost as large as the next two largest companies (Exxon and Google) combined. What does this mean for the stock market? This quarter Apple’s earnings accounted for nearly all the growth in earnings of the SP500. Said another way, take out Apple from the SP500 and earnings would be flat vs. last quarter. Apple is up 15% already this year and accounts for roughly 30% of the SP500 2.1% gain. What is the point of this exercise? When looking at where the markets may be heading, it is instructive to look at the largest weight: Apple. Many of the indicators, whether short or long-term, remain in the middle of their historical ranges. Stocks have once again begun outperforming the bond market after taking two months off. For now, we are bullish on stocks, but we are watching the Apple of the market’s eye!
The bond model continues to point to lower interest rates in the future, exactly opposite of the Fed’s desire to raise rates in June. That said, the notable weakness in some of the interest rate sensitive sectors like utilities and REITs are worth noting. Since the end of January, utilities are the only sector to have declined (by 7%!). REITs have declined by nearly 3% over that same period. Given short-term interest rates are at 0.02%, it is hard to see them going lower! IF the Fed does begin to raise rates, we can easily see the bond model flipping to a negative stance. When that occurs, we will be reducing our holdings of long-term bonds and increasing the short-term bonds.
Although Apple continues to put on a show, other parts of the market are beginning to show some relative strength. As mentioned above, utility stocks have suffered so far this year, but last year’s stinker is starting to smell a bit sweeter. Energy prices may not have bottomed yet, but many of the stocks are well above their lows of mid-January and are the best performing group so far this year. A similar story is playing out in the international and emerging markets. After each has performed poorly compared to the SP500, they are besting the index over the last six weeks. Small stocks (as measured by the Russell 2000) have merely kept pace over the last four months. Unlike the other asset classes that are beating the SP500, the small caps continue to be very expensive, even relative to the SP500. Over the last two months we have reduced our exposure to interest sensitive sectors (like utilities and REITs) and increased our weighting toward energy and related stocks.
The economic news is not really strong enough to warrant the Fed increasing rates, but they may raise rates anyway as a way to demonstrate they can. The rate picture continues to support lower rates, the Fed notwithstanding. We are finding better value and performance out of the beaten down international and energy sectors of the markets. The future is never crystal clear, but for now we remain tilted toward equities and non-SP500 names.
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.