Central Bank Week
The 90th birthday of Queen Elizabeth and her 64+ year reign is among the longest in modern times, with the current head of Thailand serving five years more. The color of purple took on many meanings this week with the celebration of Queen Elizabeth’s birthday as well as the passing of Prince. The heating up of the election season in the US is about who grabs the power to run the country over the next four years.
Common wisdom is the Democrats have a “done deal” while the Republicans are likely to go through a messy convention. Purple will take center stage as the two candidates wrestle for the reins. A calm and peaceful next few months is not likely to be the order of the day. This week we’ll get yet another Fed meeting where they are expected to leave rates unchanged. What will be watched closely will be clues as to whether they remain on the path of 2-4 rate increases this year. At the start of the year, four was expected. Most prognosticators are now saying just two. How much longer before that gets cut again? May the April rain be purple.
The role reversal in the market is nearly complete, as the “safe” stocks of the past six months get tossed onto the scrap heap in favor of those more closely tied to economic growth. Basic materials, energy and industrial stocks have all shot higher this year as energy prices jump from their February low. The big question facing investors are whether the price jumps are warranted.
Rumblings from China of economic stabilization and an increase in their importing of copper and steel has bolstered the thoughts of another infrastructure rebuild that would once again last a decade or more, like the last surge. Loan growth in China has also increased, indicating the recent activity is being fueled by borrowing and not as much from a government push. If the China story is real, they could help push global growth higher. In the US, however, growth is hard to see just yet as much of the recent data remains weak. Of course much of it has been attributed to the usual winter slowdown that will pick up as we experience warmer weather. The Fed comments later this week should provide some guidance to the markets. Will they be more confident about the quieting of international markets as a green light to raise rates at their June meeting? Expect market volatility around their Wednesday meeting.
Interest rates have moved a bit higher, expecting that the quieting financial markets may give the Fed a reason to raise rates. The debate continues to rage between those calling for an increase as employment is “maxed” out to those noting weakness in manufacturing and still low inflation data as reasons to hold off. Corporate bonds have improved as fears of bankruptcies in the energy patch subside. Similar to stock investors rotating back toward the riskier parts of the markets, so too are bond investors. Treasuries are among the worst performing assets within the fixed income market after being the best from mid-’14 to this February. As long as the economic data can show improvement and a strong argument can be made for economic growth, Treasuries will struggle compared to other bond choices.
We have been cautious investors as the markets remain relatively expensive and forward returns seem paltry for the risks taken. But there are a few things going on today that give us pause in that argument. First is that all the sectors of the SP500 are now over their long-term averages, something that has rarely happened over the past twenty years.
Subsequent returns after such an “event” have been well above average. The small cap index is doing well and more stocks are consistently rising than falling. Combined, these signposts have historically pointed to market gains of over 10% a year out. Of course, the sample size is rather small, but it is worth paying attention to the market action in the weeks ahead. Even the international markets are getting into the game, with commodity sensitive emerging markets leading the charge higher. Investors are getting a bit bullish after the run in stocks over the past two months and the scary meme of “sell in May and go away” is staring us in the face. Will this year be different? Or will stocks continue their trek higher? While there can be some additional upside, unless earnings pick up noticeably the upside is likely capped.
Other markets are beginning to flex some performance muscle compared to the SP500. Even within the SP500, former winners have taken a back seat to the riskier parts of the index. From a long-term perspective, we remain cautious, but do allow for the possibility for further gains given the market internals. For bond investors, we remain invested in corporate bonds and keeping things relatively short-term to hedge against the possibility of higher rates.
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.