Earnings Season Winds Down
April showers are supposed to bring May flowers. In the Wall Street garden, there seems to be a multitude of weeds this year. The end of April will close out with yet another Fed meeting, where rates are expected to be unchanged and little new information regarding when/if rates will rise later this year. Economic data remains caught in the winter’s chill as many of the recent releases have been below expectations. Earnings, the main fuel for the stock market, have been above beaten down estimates. The last “big” week for earnings is on tap this week before the releases fade in May. We will begin hearing the stories to “sell in May and go away” as the markets sit at all-time highs. The weaker economic data,as of yet, is not signaling a recession. The unemployment report, released next Friday, will either confirm the weakness of last month or resume the strength of 2014. Investors and maybe the Fed too, will be looking at wage growth as a sign of tighter employment conditions. The low unemployment rate has yet to spur wage growth that will be necessary if the Fed is to increase interest rates in 2015.
Since the beginning of 2014, the SP500 has been in “expensive” territory, selling for 20 times trailing earnings. Since that time, the SP500 has increased by an 11% annual clip, helped in no small part by the performance of Apple, which is up over 50% during that time. Investors have also gotten very accustomed to the persistent rise in the markets, as it has been over four years since the last 10% decline. Further, in only three weeks since 12/31/11 has the SP500 closed below its long-term average price which is similar to the run in the late 1990’s. While stocks are not nearly as expensive as in 1999, the depressed interest rate environment has had an impact upon investors embracing stocks as a way to get income (and growth). While an immediately decline is unlikely, the longer term returns will be diminished by the very high starting value of stocks today. It is for this reason a diversified portfolio makes more sense than anytime over the past five years. It is our educated guess that the SP500 will not be the best performing asset class over the next five years.
Bonds will be in the spotlight following the Fed meeting mid-week. Expectations have shifted from a June increase in interest rates to something much later in 2015 or even into 2016. While we don’t expect clarity to come from the meeting, investors will be parsing their official statement for clues. Save for a handful of weeks over the past two years, the bond model continues to point to still lower rates ahead. Commodity prices, which remain more than 20% below year ago levels, are actually up over 7% in the past month. This is not an inflationary scare, but maybe the start of a 3-6 month push higher in prices. Strength in wages could support higher commodity prices in the months ahead, all the more reason to keep an eye on the employment report due on May 8th
The asset classes have changed little over the past six months. With bonds, SP500, small cap and REIT investments all trading above their long-term average prices, it remains a market that wants to go higher. Recently international investments have managed to get above their long term averages for the first time in nearly a year. Within the SP500 sectors little has changed, as healthcare remains at the top and energy at the bottom. But that relationship masks the recent trends within the two groups. Healthcare has actually lagged the SP500 since prices peaked in mid-March, while exact opposite is true with energy. The industry group rankings use longer-term metrics, but it is sometimes instructive to look at short-term trends to determine whether the long term relationships are changing. Given the extremely long run that
healthcare has enjoyed over the past four years, it would not be a surprise to see the sector take a breather and more economically sensitive sectors, like energy, come to the fore. Given the recent improvement in international, especially emerging markets, it may indeed be time to increase weights in commodity type investments.
Merger activity has stepped up in nearly all parts of the markets, providing investor’s an added reason to stay with stocks. Mergers may only be in response to poor growth potential and companies could be using mergers as a way to increase “scale”. The very low interest rate environment makes mergers a cheap way to go large without huge costs. Keep an eye on energy prices in the weeks ahead as an indicator that commodity prices may be bottoming, lending an additional argument for holding emerging market stocks.
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.