Welcoming Spring With Snow!

PaulNolte-2Back to the Future week! Nike introduces “self-tying” shoes. Election results threaten to set the country back a few decades (depending upon your political leanings) and Fed Chief Janet Yellen held rates steady, citing as she did last fall, global economic growth and risks. The markets blithely moved higher as investors focused upon a reduction in the number of rate hikes from the Fed from four to now just two. With the official start of spring this weekend, the markets continue to bounce higher, up over 7% from their lows during the dark and cold January sell-off. The economy needs more than just low interest rates (at seven years and counting) to keep it going. While the low rates may have averted a deeper recession, it has not fueled vigorous growth. Policy makers around the world have ceded all fiscal responsibilities to put economic growth plans in place to monetary policy from central banks. Based solely on the political trail talking points, none of the candidates seem to have a cohesive plan to change that in their administration. The markets are still focused upon monetary policy, but as early spring shifts to late summer, investors may also begin looking at economic plans of the nominees.

All hail the stock market for making the round trip from a 10% decline to unchanged all within the quarter. Energy, the scourge of investors starting the year, is now in a bull market and up over 70% from their January lows. The discussions have changed from how low can stocks go to how high can they climb. With a vast majority of stocks trading above their short-term average prices, it is easy to say the markets are in high gear and just jump aboard for the ride. However, some of the same issues that faced stocks over the past year remain in place today. Small cap stocks have raced higher, but remain no better than the SP500 from mid-January. The net number of advancing to declining stocks has improved considerably and should point to some continuation of the rally, but a modest break is certainly warranted, if only for the markets to catch their breath. That decline, whenever it comes, could also tell the tale of the remainder of the year. A modest decline with many stocks holding up is the best scenario, but erosion of the market internals like we saw last
summer could spell trouble for the rest of the year.

The surprise this week was the bond market, as it continued to rally, even in the face of higher energy and commodity prices. The removal of two hikes this year from the Fed’s plate also encouraged investors. The textbook thinking is that the Fed can control short-term rates but changing the Fed funds rates and other instruments, but the long-term bonds (beyond 10 years) are determined more by inflation expectations. As those expectations rise, so do yields (and prices fall). But the long-bond has actually rallied this year, even in the face of higher commodity prices and a bit higher than expected inflation data. It may be that investors are focused more on the global central bank policy of lowering rates and deflation in some countries. The demand for the safety of US debt at higher rates than many international investors can get locally may also be fueling the strength in long-term bonds.

The furious rally in the once trashed parts of the markets has the smell of a short-covering rally. Investors who “shorted” these stocks have been surprised by the rally and have been forced to buy back those shorted shares, pushing them higher still. The rotation from the “safe” stocks like consumer, healthcare and to a certain extent utilities has also provided fuel for the energy, materials and industrial sector rallies. Internationally is a similar case, as commodity sensitive markets, like emerging markets, have done very well over the past month compared to the “stodgy” developed global markets. However, when looking back over the past 7-8 years, we have seen similar periods when sentiment shifts quickly and a short and sharp rally ensues that eventually peters out and investors once again move back to the safe haven parts of the
market. Whether this time is different will require some time to see. From a valuation perspective many of the emerging markets are very cheap, but too, they are cheap for a reason. We’ll be keeping an eye on those shifting tides. The Fed meeting and subsequent news conference provided fuel for investors as the Fed indicated they would be less aggressive in raising rates this year. Does this mean corporate earnings may suffer? Or will the “blast off” of stocks over the past month carry well past the elections? Very difficult questions without easy answers. For now, we are remaining cautious toward stocks and favor bonds as the last chapter of the low rate environment has yet to be written.

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.