Weekly Nolte Notes
To quote partially quote Elmer Fudd, the markets “be vewy, vewy quiet.” How quiet? Over the past two weeks the Nasdaq market traded higher for eight straight days, but was down for the past ten. After over 100 days, the SP500 finally traded lower by more than 1%. What usually is an every 10 day to 15-day occurrence became a “once so far this year.” The handwringing has started over the effectiveness of the Trump presidency given the inability to pass “new” Obamacare legislation. Worries about the impact upon taxes and spending programs have turned investors a bit cautious about the stock market. Given that the markets have been bid up on expectations for “something yuge,” a disappointment could mean the unraveling of those gains. The economic reports continue to point to OK growth, but certainly not the 3% many were expecting following the election. Without a meaningful tax or spending plan, economic growth will certainly be stuck at its 1.5-2% growth of the past six years. All of this then begs the question, should (or will) the Fed raise rates later this year? As quiet as things have been, it is not time for “west and wewaxation at wast!”
Even with the (finally) 1% decline earlier this week, the markets have not really impacted the long-term growth projections and technically remain in decent shape. The decline was focused upon the financials and smaller stocks, while the remainder of the market did just fine. We have been of two minds regarding this market. First is that momentum continues to favor stocks in general. With still modest economic growth, it is possible that the Fed will have a rougher time hiking rates later this year. This leaves investors with “TINA”, There Is No Alternative to stocks. But secondarily, we believe stocks are valued very richly at this point and that returns over the coming years are likely to be rather poor. The question remains the same as it has been over the past two years, when will stocks buckle? Over the past three weeks the markets have “corrected” by going sideways, allowing stocks to take a break from the straight up four month move. A little bit of fear and worry is good for stocks. Investor sentiment, while not yet bearish, has backed off a bit from their frothy bullishness. Bullish investors may become endangered in the weeks ahead if stocks continue to meander interestingly sideways.
An interesting thing is happening in the bond market. Rates are falling following the Fed’s decision to increase rates. Not only on the long-term end, but even a bit on the short-term rates. The yield curve is becoming flatter as higher short-term rates get closer to the declining long-term rates. The bond model has even flipped back to positive and has been positive in three of the past five weeks. The shift in the yield curve is also being blamed for the decline in banking stocks last week, as they feast upon a steep yield curve. Commodity prices seem to have peaked and energy prices are now well below $50/bbl. As with the economic data, the inflation data does not add up to an aggressive Fed the remainder of the year.
As usual various groups within the markets are showing very different performance. The largest US stocks have done very well, while smaller stocks have struggled this year. Within the SP500, technology has been the big winner, up over 10% while energy is down nearly as much. The broad healthcare sector has been a surprise performance. A very big winner during the “Obamacare” years, the group struggled last year. Even with the specter of some kind of different healthcare, the group has put in a very good year so far. From strictly a valuation basis, the group is reasonably priced. Finally the group that usually serves as a proxy for interest rates are the utilities. They are beating the broad market this year, as many expected higher interest rates would put pressure on the group. As the year is unfolding and we watch the reaction within the markets, it is becoming clearer that lower regulations and inflationary economic growth are in our future. The markets seem to be from Missouri – show me!
The decline this past week marked the worst since the election, which really isn’t saying too much! The momentum seems to still favor stocks compared to bonds. International also seems to be the best choice after struggling for the past four plus years. We are worried that stock valuations will eventually weigh on stocks, but that is likely to be an issue much later this year. Bond investors should keep maturities relatively short. Although we believe the Fed may struggle to increase rates this year, they may still feel the need to do so in an attempt to “normalize” rates and provide firepower for the next time they have to cut rates.
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.