Trademark Market Perspective for 1/18/16

A few thoughts on the year so far:

When I wrote the January 5^th, 2016 Market Perspective, I wanted to make the point that stocks were not fairly valued (as several market strategists had argued in their 2016 forecasts). It was not a prediction that stocks were headed lower as much as a warning that if they did, valuations would not provide much support. I also expressed skepticism that buybacks would provide much support if a stock was overvalued. Home Depot, the stock I used to make the point, is down -9.85% so far this year, trailing the S&P 500’s -8.25% start. Low volatility has also been being a better factor to emphasize in 2016 than growth. iShares USA Minimum Volatility ((USMV) has fallen -4.93% so far, 3.32% less than the S&P 500. PowerShares Small Cap Low Volatility (XSLV) is down -6.49 as compared to the Russell 2000 which is down -11.25%, and iShares EAFE Minimum Volatility (-6.14%) is well ahead of MSCI EAFE (-8.79%). Of course, cash is the ultimate low volatility asset and is, of course, beating all low vol funds.[1]

The Federal Reserve finds itself in a quandary right now. I believe they would like to tighten interest rates several times prior to the next recession but that isn’t how things appear to be working out. The Chinese are exporting a ton of deflation as a result of the failure of their economy to successfully transition from production based to consumption based and this is occurring at the same time as Saudi Arabia’s oil production gamble is crushing the global natural resources sector. Investors the world over are losing confidence in the ability of central bankers to manage the post-crisis high debt, low growth environment, as Salient’s Ben Hunt has been warning about. So the Fed can admit defeat and move back toward easing (which would probably ease the current panic but confirm the growing despair that the “new normal” environment will last for several more years), or it can soldier on with talk about more rate hikes this year on the hope that it can convince us that the economy really is as strong as they want us to believe.

Growth stocks, led by technology and health care, were the biggest winners in the bull market phase that stretched from late 2011 through 2015. Even when they corrected (October 2014, August 2015) they performed better than value stocks. It was not that way last week, as a disappointing earnings report from Intel helped knock tech stocks down another -3.34%[2]. With the tech heavy NASDAQ off -10.4% this year and AMEX biotech Index off -16%, the market is going to need to find new leadership fast.[3] As is usually the case during bear markets, a recession-resistant business with a nice (supportable) dividend and a strong balance sheet (low leverage) is going to be in favor.

Credit risk is really out of favor. We are starting to see 2008-type yields at the CCC and below part of the credit spectrum. Given the massive over capacity and over leverage in the energy, mining, and materials sectors, however, I’m not sure this isn’t warranted. Think about MLPs in 2015 – as bad as you thought it was, it just kept getting worse. Doubleline’s Jeff Gundlach makes a very good point in Barrons: if junk bonds are right (and default risk is really this bad), then stocks potentially have a lot farther to fall.

I try to avoid making market timing calls. I just suggest being defensive right now. One of the ways I’ve tried to accomplish that is through managed futures funds. This could be a way to make a positive return when multiple asset classes are in decline. Markets can change in a hurry (especially if central banks intervene), so this is an area where you should tread lightly, and perhaps divide your exposure through two or more managed futures funds.

[1] Source: YCharts.com

[2] As measured by the NASDAQ. Source: YCharts.com

[3] Source: YCharts.com