Greek (Again) Center of Europe
Last week we highlighted the new jobs for former Fed Chief Ben Bernanke. This week it seems as though the current chief, Janet Yellen, was auditioning for a spot in the private sector. Her comments about the high valuations of the equity market sent stocks lower. Her follow-on comment was that the Fed is better prepared to handle the next crisis. Of course, the next crisis won’t look like the last one. Her comments, coupled with the spike in German bonds from near zero percent to 0.80% within a week’s time, unnerved the equity markets. The big economic report of the week, unemployment, reversed last month’s weakness as payroll gains are back over 200k. Equity markets rose following the report although job growth has slowed a bit from 2014 and wage growth remains anemic. The coming week will see a few earnings reports, but the focus will be on retail sales. The report is a good barometer of consumer feelings about the economy. Outside of slower auto sales, it is expected to be much better than the first quarter as the weak winter spending gives way to the Spring thaw. While the seasons change, one season, the election season, seems to never end. Eight candidates have declared for the White House with another eight listed as probable. The British have it correct on this one, as it is less than forty days from the beginning to the end of their election season.
The popular market averages were able to notch gains on the week, however market internals were little changed from the poor prior week. More stocks fell than rose for the week and volume picked up noticeably on the down days vs. the up days. Finally, investor sentiment remains very bullish. Dammit Janet, the markets are indeed expensive! But that does not automatically mean stocks will immediately decline. There needs to be a catalyst, which many worry is a Fed bent on raising rates. Whether they will or not and when they will is the question many articles try to answer in explaining why the markets either rose or fell that particular day. The market internals are neutral at best, even taking into consideration the concerns above. Slower earnings growth is of greater concern than just a high valuation. If earnings cannot gather any momentum during the second quarter, it will be increasingly hard for investors to justify paying over 20 times earnings for less than 5% annual growth. If that gets coupled with a Fed insistent on raising rates, then the admonishment from Janet will be indeed be clairvoyant. Her actions will be louder than her words.
The global bond markets were roiled last week, as European interest rates shot higher from extremely low levels. In the US, the 20 year Treasury bond fell over 4% before recovering later in the week. This normally sleepy part of the financial markets has been much more volatile than their equity cousins. The very short-term bonds remain stuck near zero due to the Fed’s heavy boot keeping them there, but that is expected to change “sometime” in the future. Investors have been exiting longer dated bonds and other interest rate sensitive parts of the markets for the safety of short-term bond investments. The modest rise in commodity prices over the past month is increasing fears that the Fed may actually raise rates sooner than many are now expecting based upon the still slow economic environment.
Changes in the markets, to paraphrase Hemingway, happen gradually, then suddenly. Although much of the energy sector has rallied this year, they remain at the bottom of our ranking system. Positive momentum has been seen in the prices of many energy stocks recently, but they remain a very long way from the heady days of $100 bbl oil prices. Healthcare is at the other end of the spectrum. They have been the darlings of Wall Street for over four years, benefitting from an aging population and changing healthcare policies. What is not priced into each of these sectors is the possibility that things will change. Oil prices do not need to get back to $100 for many companies to become profitable. Healthcare, like consumer staples and utility companies before can get to extremely high valuations that no longer provide reasonable future returns from those high levels. Call it reversion to the mean or a correction, but the momentum has begun to come out of the healthcare sector over the past month, just as it has ramped up in the energy sector. There two key sectors bear watching in the weeks and months ahead.
Stocks are looking a bit weary as they have essentially traded sideways, in a dramatic fashion, for the past three months. Large future gains will be harder to come by without better economic conditions and earnings reports. That said, better opportunities can be had in the international markets as the dollar has begun to correct its very strong rise during the last half of 2014. Many of the international markets are selling at a fraction of the valuations in the US and have the added benefit of being ignored for much of the past five years.
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.