All eyes are on two things this week – the U.S. Federal Reserve meeting and the Dutch election. The former is expected to end Wednesday in a 25 basis point rate hike. Depending on the market’s assessment of the tone in the comments that accompany the rate hike, stocks and bonds could conceivably have a relief rally. That said, this bull market has been built on low borrowing costs. No matter what the fund company propaganda tells you, it will not tolerate three rate hikes in 2017 well. The Dutch election is seen as a referendum on European populism and by extension the future of the Euro experiment. A strong showing by Geert Wilders will be taken as a sign that the “common” European citizens have had enough of the EU, and the portents for the more important French election in April will be ominous.
Energy prices have been falling in recent weeks on data showing supply consistently running ahead of demand. Apparently U.S. shale producers are only too happy to fill any supply gap stemming from OPEC production cuts. As prices fall into the upper $40s and stay there, how long before the Saudis get exasperated and flood the markets again? I think this is a risk, and I would add that oil prices and the U.S. stock market as a whole don’t historically move in opposite directions for long.
Emerging markets have done well so far in 2017 as the MSCI Emerging Markets index is up 8.8% through March 13th. See Chart 1. These are some of the reasons:
- The U.S. dollar was expected to soar but it opened the year weak and has only begun to recover as Wednesday’s Fed meeting approaches.
- The EM news has largely been good. For instance, Modi’s party in India picked up seats in regional elections, economic growth edged higher in China for the second straight month and Argentina’s expected economic contraction in 2017 has been almost completely erased.
- Valuation remains attractive relative to developed markets.
Here’s a few emerging market funds I feel have done a good job.
Fidelity Emerging Market Discovery
- Ticker: FEDDX
- Though the management team has been on the fund for less than three years, I like this fund. It’s more of a midcap value fund so you don’t get the same positions you tend to get in the average EM equity fund like Taiwan Semiconductor and TenCent Holdings (which are usually also found in large cap international funds).
Templeton Global Bond
- Ticker: TPINX
- The fund has positioned itself as a dollar-bullish (and Yen bearish) world bond fund. Much of its holdings are in emerging markets, but from a currency standpoint that doesn’t really matter – it tends to do very well when the dollar is up (and the Yen is down) and poorly when the opposite is true and hence its terrible relative performance from 2014 through August of last year and its category crushing return since September.
Another sector I’m warming up to is biotechnology. The health care sector (biotechs included) was crushed in 2016 by overvaluation and concerns that either presidential candidate would put limits on drug company pricing. Overvaluation is for the most part not a concern now, as multiples have come down in this sector and risen almost everywhere else. Regulation is still a concern, but not as much as it would have been had the Democratic candidate prevailed. In any event, biotech companies rely less on protecting the pricing of blockbuster drugs like the major pharma companies do, so for the most part they are less vulnerable to what Washington might do. A few funds I believe have done a good job in this sector are Fidelity Select Biotech (FBIOX) and T. Rowe Price Health Sciences (PRHSX). It should be noted that T. Rowe Price Health Sciences has a new fund manager in Ziad Bakri. Also, this is the second time in four years the fund has experienced a manger change so proceed with caution.
Last week was a bit of a wake-up call for high yield bond investors. I had mentioned that yield spreads over Treasuries were at multi-year lows, so there was no room for any kind of bad news. You can never tell in advance when this particular “rabbit” is going to get spooked, but it certainly did last week as high yield gave up all its 2017 gains in just six days. On February 27th the iShares High Yield ETF (Ticker HYG) was up 2.5% and proceeded to give it all back and more. See Chart 2. I believe the best strategy in this sector right now is to get defensive, both in duration and credit quality. When the Fed is clearly in tightening mode, the focus for bond investors has to be on preserving principal, not generating superior returns.
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