Weekly Nolte Notes
All the “Yellen” about higher interest rates has people thinking the Fed will actually raise the markets in two weeks. In a week chock full of Fed speakers, Ms. Yellen on Friday indicated rates would be bumped up if employment and inflation continue to meet expectations. We’ll get the employment report this Friday and inflation data just before their meeting. Expectations for an increase went from less than 30% to nearly 90% just this past week. On top of the promise of “trillions” of spending on infrastructure by President Trump in his Congressional speech Wednesday, Fed policy is likely to be tighter than many expected (including us!). Much of the economic data over the past few weeks has been coming in stronger than initial estimates. Inflation has picked up with commodity prices higher than year ago levels. With the markets at/near all-time highs and up significantly this year, it provides plenty of cover for the Fed to raise rates. Only a terrible turn in the data could put the Fed on hold. Based upon all that has hit the wires over the past few weeks, we now expect a move in March combined with a press conference discussing the decision.
The markets continue to confound the best guesses of the experts. Many are combining politics with economics and earnings. Stocks have moved on earnings and earnings expectations. Those have actually ramped up over the past few months. Fears of a Trump Presidency have thus far been overblown. While we remain very concerned the market valuation is among the highest of all time, the short-run picture remains generally positive. There has been some weakness in the number of stocks above short and long term averages, but the net number of rising to falling stocks remains very strong. Volume has picked up on days when the markets are higher. Finally, the number of stocks making new highs hit its best level since December, indicating plenty of stocks are participating in the rally. For only the second time this year has the net number of stocks declined vs. advanced on a weekly basis. Outside of a weak December, it marks the third time since the election that this has been the case. It can be easily argued that stocks “should” correct, if only due to the distance covered since the election without much of a break. As we’ll discuss below, we are seeing some rotation toward the more conservative parts of the markets, indicating investors are beginning to look for shelter.
After beginning to find a bottom in prices (highs in yields), the shift in expectations for a rate hike put bonds on their back. Yields actually rose more on the long end than the short. Investors shifted to shorter maturities to reduce the potential losses from a rate rise. The inflation portion of the data released last week is showing price increases at their fastest rates in over six years. It will take a few months to see if those increases on producer goods make it through to the consumer. The employment report on Friday will be watched closely for continued wage gains. We expect the Fed to hike in two weeks; the bond market is quickly making the same assessment. What happens after that increase? We’ll be data dependant!
Within the US markets. the larger the company– the better the performance. The SP500 is up just over 6.5% year to date, while the largest 100 stocks are up over 10%. The smallest stocks are up less than 3%. Although there was supposed to be a change in leadership from the SP500 to “other” parts of the market, that event has yet to occur. In fact, the SP500 ETF saw a huge influx of cash on Wednesday as investors pile into the most liquid parts of the market to capture whatever gains they can. Within the SP500, there has been a subtle shift toward the “defensive” stocks. Healthcare and utilities are both up 6%+ this year while energy, materials and industrial stocks (part of the Trump trade) are up less than half of the market (energy is actually down). The financial sector, the new favorite of investors as expectations of a less onerous regulatory environment, buoys prices. The financial sector is also seen as a beneficiary of higher interest rates. If the spread between short and long term rates continue to widen, banks will be able to generate additional income as well.
We are beginning to shift portfolios toward a more conservative stance, reducing the industrial sector and some of the weaker technology names using the proceeds to increase weights in healthcare and utilities. We still like international and emerging markets and will be leaving those holdings alone for now. Bond investments will be using recent maturing bonds to focus on the 3-5 year window to slowly shift toward a shorter duration for bond portfolios.
The opinions expressed in the Investment Newsletter are those of the author and is 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.