Market Perspective for April 4th, 2017
Stocks gained 6.07%, as measured by the S&P 500, last quarter.[1] That’s a very nice rate of return (over 24% if annualized). It suggests that everything is going well economically. Paradoxically, interest rates have actually fallen, which is more indicative of a weakening economy. What’s going on here? A look at the performance of industry groups offers an explanation. The most economically sensitive industries – energy, transportation, financial services, and retailing – have either fallen or are up just modestly. The best performing sectors tend to be those that are fairly indifferent to the economic cycle – technology, heath care, utilities and consumer staples. In short, the winners under Trump look a lot like the winners under Obama. Thus far, betting on continuous but unspectacular growth continues to pay off while betting on either slipping back into recession or surging toward inflationary growth has been much less rewarding.
If there is any significant difference so far between Trump and Obama from an investing standpoint, it might just be in foreign markets. Foreign stocks and bonds slumped after the election on the idea that the U.S. would pursue pro-growth strategies that would boost the dollar and inflation. That has not happened so far. As a result the dollar has given up significant ground, allowing emerging markets to soar over 11%[2] and developed foreign markets to gain 7%[3] (in dollar terms). For obvious reasons, it is a lot easier to make money investing overseas when the dollar is falling.
I believe the dollar has seen most of its near term decline already, so I’d be cautious about extrapolating that trend. The 200 day moving average is still rising, though the 50 day has turned negative. That tells me the dollar is trendless right now. (I am aware that that statement might not be all that helpful.) U.S. investors are still buying the dips on the idea that tax cuts (the real prize, as opposed to health care reform) are still coming, and successful legislation on taxes is expected to be very dollar bullish. Others have lost faith in (or fear of) what the U.S. might do and expect the dollar to eventually fall to the range it occupied from 2012-14. Inflation and growth have already picked up in the Eurozone, so the next rate move there is likely to be an increase.
Asset Allocation
- Growth significantly outperformed value due to the lack of action on either the tax or regulatory front. It seems certain that there will be a major tax overhaul at some point in the next few months, but the prospects for a major infrastructure bill seem to have lessened considerably. At the margin I would look to shift a little bit from large cap value to large cap growth. Technology has had a great run (12.5% last quarter) and might need a bit of a rest, but health care could pick up the slack in light of its fairly weak 2016 performance. Financials (the largest weighting in value stock funds overall) have been the most hurt by legislative non-action. Long bond yields are kind of a proxy for financial stocks right now, and they have been going in the wrong direction. At some point, maybe in the fall, the cyclical-over-secular-growth trade is likely to return.
- Emerging markets are the biggest beneficiary from the Trump agenda not being enacted so far. No border tax means no dollar surge, which was a happy surprise for Asian and Latin American markets (which gained 12.9% and 15% respectively).[4] That kind of return is not going to be repeated go forward, regardless of what happens, because the surprise factor is gone. I am skeptical that Latin American can continue its momentum if commodity prices level off, which I think will happen. I prefer Asia – especially India, where banking reform stands to deliver significant benefits.
- Europe is attracting inflows as investors are extrapolating a favorable result in the Dutch election in March to the much more significant French election this quarter. While centrist Emmanuel Macron seems likely to win the run-off on May 7th, there could be a great deal of nervousness after April 23rd if his election opponent is nationalist Maxine Le Pen (as polls suggest). Even if Macron wins, the market may have already discounted it such that all investors would gain is what they lose from now until Election Day.
- Small cap stocks gained just 1.06% last quarter according to the S&P 600 Index.[5] With median stocks trading at all-time record highs in terms of PEG ratio (price to earnings ratio compared to growth rate), Enterprise Value (the value of both stock capitalization and outstanding debt) to Sales, and Enterprise Value to EBITDA (earnings before interest, taxes, depreciation, and amortization), it can’t be argued that investor love for indexing is distorting the market in favor of large caps. As long as the current circumstances remain in place (high valuation and no meaningful acceleration in economic growth) I expect small caps to under perform large caps so I would underweight them.
- According to S&P Real Estate Index, that sector gained 3.54% last quarter. Don’t feel bad if your real estate fund did not measure up. According to Morningstar, 12 real estate related funds and ETFs beat the category average and 254 did not. The Vanguard REIT index fund gained 0.95%, so I think we should be very skeptical of S&P’s numbers. In any event, real estate has been struggling lately and no area of that market has done worse than retail REITs. Malls are having a hard time because retail itself is undergoing structural change. There is a shakeout underway, and it has a ways to run. Perhaps this is an opportunity for great real estate stock pickers to add value versus the index, but at this point I’m not interested. 266 real estate funds is too many. The sector is over-owned due to the desire for income. Underweight real estate.
[1] Source: S&P Dow Jones Index Dashboard: US March 31,2017
[2] S&P Emerging Market Index as reported by S&P Dow Jones Index Dashboard: US March 31,2017
[3] S&P Developed Ex-U.S. Market Index as reported by S&P Dow Jones Index Dashboard: US March 31,2017
[4] S&P Latin American 40, S&P Asia 50 as reported by S&P Dow Jones Index Dashboard: US March 31,2017
[5] Source: S&P Dow Jones Index Dashboard: US March 31,2017
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